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Dollar’s rise puts currency hedging on the table again

Jay C. Rehak
Jay C. Rehak said the Chicago Teachers fund doesn’t pay much attention to currency fluctuations.

(updated with correction)

The dollar's rise is bringing the issue of currency hedging back into some institutional investors' conversations.

Executives from managers like BlackRock (BLK) Inc. (BLK) and J.P. Morgan Asset Management (JPM) suggest perhaps now is a good time to be reviewing and considering currency exposures for multiasset-class portfolios, and consultants suggest there might be value to engaging in strategic hedging.

And currency hedging is on the list of discussion items for the investment committee of the $14.2 billion New Mexico Public Employees Retirement Association, Santa Fe.

But still there are those asset owners, consultants and managers who believe currency over time is a wash, and therefore the cost of hedging programs isn't worth it to the long-term investor.

The U.S. dollar rose nearly 4% against a basket of currencies following Donald Trump's November election win and is up roughly 25% since 2014. It dipped a bit following Mr. Trump's comments about the dollar being too strong, but rallied on Jan. 18 after Federal Reserve Chairwoman Janet Yellen said the central bank expects a few rate hikes a year through 2019.

Celia Dallas, chief investment strategist at Cambridge Associates LLC, Arlington, Va., cited a major reason long-term investors are still skeptical about implementing currency hedging programs: uncertainty as to where the dollar will move.

“It's not a foregone conclusion that the dollar is going to appreciate,” she said.

“There's a lot of uncertainty in the currency arena today centered (on) what protectionist policies there will be. This is a complex challenge for investors,” she added.

Added Steven J. Foresti, chief investment officer of Wilshire Consulting, Santa Monica, Calif.: “It doesn't seem important to pay the costs of putting a currency program in place. But the conviction to that approach is tested when you're in a strong dollar environment. I think that's what's going on now.”

Although there are some benefits such as hedging risk and taking advantage of fluctuations among currencies, many executives interviewed for this story ultimately don't think hedging programs for long-term investors are worth the effort — or cost. Paul Bosse, a principal with Vanguard Group Inc.'s investment strategy group, said in a phone interview that “very long-term investors probably should not hedge,” because not only is the rising dollar “not a sure thing,” but also “there's no embedded return,” because currency is a risk factor.

“Studies have shown that long term, there's no return to currency. It's simply noise. It's risk and you have to decide if you want to get rid of it, and at what cost?” he said.

'Just not worth it'

Jay C. Rehak, president of Chicago Public School Teachers' Pension & Retirement Fund's board, agreed with Mr. Bosse.

“We find that those vehicles are very expensive and not cost effective. We looked into it a few years ago and it's just not worth it,” Mr. Rehak said.

The board president added that because the $9.7 billion pension fund is a diversified portfolio with global assets, fluctuations among different currencies within the portfolio occur with some frequency — it's nothing to be worried about.

“Currency fluctuations happen all the time. It doesn't mean a whole lot to us. We hold steady with the course we take,” Mr. Rehak said.

That said, Mr. Rehak noted the Chicago-based fund has exposure to non-U.S. markets and those individual managers may choose to hedge some or all of their currency exposure.

The $192.2 billion California State Teachers' Retirement System, West Sacramento, “looks at its investment strategy in terms of years and decades ... (and) adjusts its investment activity within this larger framework,” spokesman Ricardo Duran said in an email.

Added Mr. Duran: “We expect to continue our portfolio shift to reflect a more global orientation, adjusting tactically to the impact of currency fluctuations.”

Despite the skepticism of some, Jonathan Grabel, chief investment officer for the New Mexico Public Employees Retirement Association, said the investment committee plans to discuss currency hedges this month.

“It's a very topical story. It's not the first time that currency matters, but certainly the consensus is that we're in a low-return environment, and anything additive to returns matters more in a lower return environment,” Mr. Grabel said.

Interest in such programs among U.S. pension plans has grown and continues to grow, one provider of currency hedging programs said.

“We've seen a steadily growing awareness of the capabilities of currency management for both currency risk management and making money out of movement in currency markets,” said James Wood-Collins, CEO of Record Currency Management, based in Windsor, England.

Mr. Wood-Collins noted that in recent months most inquiries from U.S. asset owners his company received are for constructing currency programs to achieve both of these objectives.

“A number of asset owners are saying: "We're concerned about the risk that a strengthening U.S. dollar could bring to our portfolio, but we also recognize that there will be periods in which the dollar is strong but also periods when the dollar may weaken,'” he said.

So Mr. Wood-Collins is finding many U.S. investors are seeking an “active or asymmetric hedging program” that adjusts the level of hedging based on the strength or weakness of the U.S. dollar. In other words, it implements less or no hedging when the dollar is weak.

Headwinds will occur

Money managers believe that, with the dollar likely to stay strong in the near future, asset owners need to acknowledge the headwinds that will occur as a result and suggest that hedging may be ideal for investors' multiasset portfolio.

Terry Simpson, multiasset strategist for the BlackRock (BLK) Investment Institute, said the New York-based money management giant has been recommending to its clients that they should be hedging international conditions, mainly those in Europe and Japan.

“It's a common theme that's being brought up in my conversations,” Mr. Simpson said. “I suspect we'll have more interest in this.”

The BlackRock executive explained that asset owners running unhedged positions may potentially not capture benefits of these improving economies.

“From a general dollar strength environment, this is somewhat of a concern because it's an explicit tightening of global financial positions. So that's a major headwind,” he added.

Meanwhile, Ben Mandel, global multiasset strategist at J.P. Morgan Asset Management (JPM), said that although most of the strategies JPMAM manages are dollar-based, he noted that “clearly sensible investors would express interest in overlays.”

“The strong dollar is a symptom of global reflation. As a result, we see the strong dollar being part and parcel of an incremental shift in taking risk,” Mr. Mandel said. “It makes investors more willing to take on risk in a multiasset portfolio.”

Wilshire's Mr. Foresti and Cambridge's Ms. Dallas agreed that they're seeing less hedging going on among institutional investors and less advocating of currency hedging from money managers.

Indeed, Pensions & Investments data show 63% of defined benefit plans in the largest 200 U.S. retirement plans don't have currency hedging programs.

Still, both consultants said they've been recommending clients should be asking themselves whether to engage in strategic currency hedging.

“We like to focus on the strategic role of currency in the portfolio,” Mr. Foresti said, noting “less hedging going on would seem to make sense from a strategic perspective.”

There are multiple reasons for this, he said, but the biggest among them is long-termism. A long-term investor thinking strategically typically thinks the risk connected to currency fluctuations washes out over time.

Ms. Dallas said “that's certainly a reasonable strategy, but I don't think you can ignore the currency aspect,” she said. “Currency matters a lot. It matters more when interest rates are so low.”

The bottom line for investors, she said, is: “Hedge or don't hedge, but understand your organization and take that into consideration with your investment exposures.”

This article originally appeared in the January 23, 2017 print issue as, "Dollar's rise puts currency hedging on the table again".