Many international equity managers have begun - or stepped up - currency hedging as they see the dollar climbing above its historic lows.
The more bullish dollar outlook follows a rise in the U.S. currency since its March/April lows. On March 8, the dollar hit 1.343 German marks; on April 19, it fell to 79.75 Japanese yen. Generally, it has improved since.
But two weeks ago, signs of a weakening dollar prompted concerted central bank intervention to buy billions of dollars. Reports also circulated that the U.S. government would not favor a weaker dollar as a way to influence its current efforts to penetrate Japan's auto market.
The currency protection programs under way typically consist of hedging foreign currency back to dollars, because a rising dollar hurts the value of Americans' overseas investments. Right now, much of the hedging is being directed toward the Japanese yen; however, some managers are hedging their exposure to European currencies.
Among the hedgers:
G.T. Capital Management, San Francisco, has 60% of its yen exposure and 25% of continental European currencies hedged back to dollars.
The $14 billion Tennessee Consolidated Retirement System, Nashville, has increased to close to 50% its hedging of its yen, mark and British pound exposure - in both stocks and bonds, said Chief Investment Officer Charles Webb. Previously, the hedging had been averaging about 20% of that currency exposure.
The $48 billion New Jersey Division of Investment, Trenton, may again increase the amount of currency hedging, although not long ago it was lowered as the fund made some portfolio shifts, said Roland Machold, the fund's director.
RCB International Inc., Stamford, Conn., now has 80% of its yen currency exposure and 80% of its French franc exposure hedged to dollars.
London's Delaware International Advisers Ltd. "is hedging significant parts of its continental European currency exposure and virtually all of its yen," said Director Ian Sims.
Edinburgh-based Blairlogie Capital Management recently hiked its Japanese stock market holdings nearly to index weighting, but trimmed its exposure to the yen (the firm is now about 15% underweighted in yen).
Not long ago, Edinburgh Fund Managers hedged about 20% to 30% of its yen exposure for U.S. and Canadian clients - an amount that should increase if the dollar weakens again, said Lloyd Beat, the firm's assistant director, investment manager.
Managers foresaw weakening
Even before the recent moves in the dollar, some managers saw signs that high-valued foreign currencies had to weaken. To Malcolm Tulloch, international strategist with G.T. Capital Management, "the strength of foreign currencies is creating a recession in their economies." This already has forced Japan to cut interest rates to reflate the economy. Europe is behind Japan in the reflation process, he said, but within the next three months, monetary policy should be easing in Europe, which should help lower the value of those currencies.
According to consultant Michael Beasley of Strategic Investment Solutions, San Francisco, hedging is picking up these days among international equity managers. A number of international/global bond managers began the process last year.
Clearly, hedgers foresee the dollar strengthening, at least for the short term. But they also recognize the risks embedded in it.
Because currencies can swing sharply and unexpectedly, they can whipsaw returns of those who are wrongly positioned. That problem stung some managers earlier this year, when the dollar tumbled to record lows - at a time when some dollar bulls had hedged their foreign currencies.
When managers err in their currency judgment, they risk underperforming their competitors and an unhedged benchmark - which is the kind many pension funds use.
Said David Gould, a director of Lazard Brothers Asset Management in London: "The majority of people lose money on hedging." His firm avoids currency risk by maintaining a neutral index weighting in currencies regardless of its allocations to the underlying markets.
Rodger Scullion, chief investment officer of Murray Johnstone International Ltd., Glasgow, Scotland, doesn't believe hedging would be cost-effective now. He only expects the dollar to gain 5% to 6% this year. An alternative strategy is to "buy assets in countries whose currencies are linked to the dollar or stocks of companies that export heavily" to the United States. Mr. Scullion says his firm uses both of these strategies.
"We must remember that there are still structural problems that affect the dollar," he says. These include the U.S. federal budget deficit and the current account deficit.
Protecting yen exposure
However, other managers see good reasons to protect their foreign currency exposure, especially the yen. Edinburgh Fund Managers' Mr. Beat says his firm is "keen on the Japanese stock market," where the firm now has a 45% exposure in portfolios following the Morgan Stanley Capital International Europe Australasia Far East Index. But because "it's more likely that the yen will weaken rather than strengthen " in the near future, "the risk/reward profile favors some currency protection."
Blairlogie's managers expect that a weakening yen will help boost the Japanese market. That outlook prompted the firm to take two recent moves in Japan - it boosted to nearly index weighting its holdings of Japanese stocks, but reduced the yen exposure to a 15% underweighting, said Darren DeVore, the firm's marketing and client service director. Those actions reversed Blairlogie's first-quarter strategy, which involved being underweighted in Japanese stocks but being long the yen.
Besides its yen-related activities, Blairlogie also recently put on a "moderate" amount of hedging of European currencies.
Managers at Delaware International "think there is a good chance of a substantial upward move in the dollar in the next 12 to 18 months," said Mr. Sims. Their rationale: "the Japanese current account surplus is set to fall on a trend (like) basis. And we think that the real rate of return on Japanese assets - particularly bonds - is now not big enough to support this level of the yen."
