Currency overlay management - the business of shielding overseas assets from adverse currency swings - has failed to attract wide interest among U.S. pension funds.
Currency overlay was being applied to only 10% of the foreign equities holdings of U.S. tax-exempt institutions at the end of 1993, according to InterSec Research Corp., Stamford, Conn. Of the $204 billion in foreign equities holdings, currency overlay was used on $20 billion.
(Most often, currency overlay is applied to equity investments, because the management of global/international bonds typically includes the handling of currencies.) Officials at GK Capital Management Inc., a currency overlay manager, contend some $50 billion of international assets now have currency overlay management applied to them.
Still, some pension funds have hired currency managers this year, including the $5.1 billion Kansas Public Employees' Retirement System, Topeka, which hired Pareto Partners; the approximately $2 billion pension fund of Southern California Edison Co., Rosemead, Calif., which hired Bridgewater Associates; and, reportedly, the roughly $13 billion pension fund of Ameritech Corp., Chicago. Calls to Ameritech officials were not returned.
The $5.4 billion World Bank pension fund, Washington, uses hedges, applied in-house, on a varying portion of the fund's international equities, said Nestor Santiago, director of the pension department. The fund has been considering the use of currency overlay management, but a question exists over whether the fund should go so far as to have currency as a separate asset class (introducing such techniques as cross-hedging).
In July, the Kansas fund hired Pareto Partners, London, to manage the currency component of an indexed $300 million international equities portfolio managed by Bankers Trust Co., New York.
The Kansas fund hired Pareto to manage currency because Bankers Trust "doesn't hedge, and we didn't want to have that type of (unprotected) exposure," said Elizabeth Miller, investment officer. The fund's four active international managers all have the latitude to hedge their currency positions, "and to some degree, do use hedging in their process," she said.
Officials at Pareto Partners said the firm landed four new clients this year, including the Kansas fund, lifting its assets managed by currency overlay to $8 billion as of August from $4.3 billion at the end of 1993. Business "has not been slow for us," said partner Lynne Minard.
But on the whole, the service has suffered from such factors as a weak dollar and the overall feeble performances by quite a few currency managers.
In the three-year period ended June 30, the median manager in InterSec's FxPERF currency management program underperformed InterSec's global index (composed of four currencies) by 60 basis points. "So it may be said that the average currency manager in the FxPERF universe is not adding value over the index," said InterSec's Michael Savage, assistant vice president.
Over a longer period, currency managers fared better. From Jan. 1, 1987, through June 30, 1994, the Ferrell FX Index of Ferrell Capital Management, Greenwich, Conn., posted a 20% compound annual return, compared with a 12.01% rise in the Standard & Poor's 500 Stock Index. But the index (now representing 39 firms with 41 programs) has shown "declining returns" over the last four years, said Virginia Parker, Ferrell Capital's managing director.
Indeed, the Ferrell FX Index dropped 2.6% between Jan. 1 and June 30 of this year.
Performance problems stem from conflicting political/economic winds blowing onto the currency markets. These have heightened market volatility and unpredictability, as was seen this year. Early in 1994, many in the foreign exchange market expected the dollar to be gaining in step with growth in the U.S. economy; instead, the dollar fell.
This unruly environment has been none too appealing to pension executives, who want to avoid making mistakes.
"Historically, many pension funds have become upset because it costs them money to hedge (their currency exposure) when it would have been more profitable for them if they hadn't," points out Ms. Parker.
Ms. Parker expects that "as soon as the dollar strengthens for a quarter or two in a row, and pension funds have to go through the pain of giving up potential returns from an asset class because of currencies, then the phone will ring for currency overlay managers. But it will take (such) a wake-up call" to stir interest.
So far, San Francisco-based consultant Callan Associates hasn't yet detected any such clamor. At its June conference - attended by about 80 pension fund executives and money managers - no one in the audience, when asked, said he or she was using currency overlay management, recollects James Can Heuit, a vice president.
"I have not been surprised that it hasn't caught on," said Mr. Heuit. "The vast majority of money managers do take currency into account" when managing assets, and "plan sponsors already have a significant number of managers to follow. Until another strategy is proved to add value, I don't think plan sponsors want another manager to monitor."
Janet Becker-Wold, vice president and international consultant at Callan, adds that when currency hedging becomes necessary, many fund executives are likely to turn to their international equities managers. They "feel they should try their equities managers first because, when equities managers make country and even stock bets, they're probably" weighing in currency factors, she said.
But if stock managers don't "add value" in the currency area, they may opt for overlay managers, she added.
Debate still rages over whether international equities managers should themselves manage the currency component.
Ray Dalio, president of Bridgewater Associates, Wilton, Conn., which offers currency overlay, believes most "international equities managers don't hedge" currency exposure. "Most say they can't handle it."
Given Mr. Dalio's belief that the dollar will rise "something in the order of 20% against an EAFE basket of currencies over the next two years or so," he feels investors will need "somebody whose job it is to hedge the currency."