Major Dutch pension funds are adopting currency management strategies as they wrestle with a strong guilder and growing international diversification.
Funds that have selected or are considering hiring external currency managers include the giant Algemeen Burgerlijk Pensioenfonds, Heerlen; Pensioenfonds PGGM, Zeist; Stichting Bedrijfspensioenfonds KPN, Groningen; and Shell Pension Fund, The Hague. Other funds are handling the process internally.
The arguments for adopting currency management programs are particularly strong for Dutch pension funds, which have been diversifying outside of their domestic stock and bond markets.
During the past five years, the average Dutch fund has boosted international equity exposure to 19% of assets from 16%, while international fixed income has grown to 7% of assets from 5%, according to Cees Westland, sales and marketing executive at The WM Co., Amsterdam.
"Holland is a logical country (to engage in currency management) because the pension funds are so huge, and are huge relative to the size of the local capital markets," said Rod Porter, president, FX Concepts Inc., New York. Dutch equities comprise only 2.3% of the Morgan Stanley Capital International World Index.
In addition, the long-term strength of the guilder has made hedging more important. This situation contrasts strongly with the dollar, which has experienced significant volatility, or the pound, which has declined steadily over longer time periods, offering currency gains on overseas investments.
For the 10-year period ended Dec. 31, a hedged global bond portfolio would have returned an annualized 9.6% to a Dutch investor - 420 basis points greater than the 5.4% return from an unhedged portfolio, according to Frank Russell Co., London.
A hedged global equity portfolio has outperformed an unhedged portfolio in seven of the past 10 years, said Gareth Evans, head of currency management at Goldman Sachs Asset Management, London. On an annualized basis, the hedged portfolio has returned 11.84% a year vs. 7.04% for the unhedged portfolio.
While investors cannot bank on that type of incremental return to continue, they can expect significant reductions in volatility, said John Gillies, a director at Frank Russell. During that same period, the standard deviation of a hedged bond portfolio was 6.8%, well below 11.2% for an unhedged portfolio.
"It's a zero-sum game on returns but a free lunch on volatility," Mr. Gillies said.
Henk Klein Haneveld, managing director of William M. Mercer Klein Haneveld Investing Consulting B.V., The Hague, said Dutch funds are moving toward fully hedging their international fixed-income portfolios or limiting those portfolios to deutsche mark bloc currencies.
Dutch pension executives typically view bond portfolios as lower risk, and thus are seeking to hedge against currency fluctuations, he said.
On the international equity side, opinions are divided, Mr. Klein Haneveld said. Some pension executives believe currency is part of the investment and should not be hedged, while others want to offset the risk, he said.
Other Dutch pension experts view currency as a separate asset class, he added.
In addition, Robert Baker, a senior consultant at William M. Mercer Ltd., London, said the growing use of asset/liability studies by Dutch funds has caused them to focus more on their exposure to currency risk.
For larger Dutch funds, which have adopted specialist manager structures where the funds are responsible for asset allocation decisions, there is a greater need to control currency risk, Mr. Baker said. "In a specialist structure, you have to think about how currency should be managed," he said.
For the 185 billion guilder ($111 billion) ABP fund, which covers Dutch civil servants, its growing international allocation is driving the interest in currency management. The fund now is 6% invested outside of Holland, but foreign investments are expected to increase to about 25% by 2000.
In the past, the fund has employed a 50% currency hedge on a strategic basis as a way to protect against risk. Now, however, fund officials have started a search for currency overlay managers for tactical purposes, either on a fundamental or a technical basis, a fund spokesman said. Fund officials hope to achieve incremental returns as well as to protect against currency volatility.
Similarly, the 54 billion guilder ($32.4 billion) Pensioenfonds PGGM is seeking a currency overlay manager to protect against downside risk and to add incremental returns, a spokesman said. A final selection is expected in October "if all goes well," he said.
Meanwhile, Jan Willem Baan, head of investments at the 6.7 billion guilder ($4 billion) Stichting Bedrijfspensioenfonds KPN (formerly known as PTT Pensioen), said his fund recently hired an external manager to hedge against its U.S. dollar and yen exposure. If the program is successful, it will be expanded, he explained.
More than half of the fund's 2.7 billion guilder equity exposure is invested outside of Europe.
Mr. Baan said the fund picked an active quantitative firm to control against currency risk. Sources said KPN had picked Pareto Partners, London, but both Mr. Baan and Pareto executives declined to confirm the choice.
The 16.3 billion guilder ($9.8 billion) Shell Pension Fund also uses currency hedging on a tactical basis. While hedging against currency volatility risk is the prime purpose of the program, fund officials also seek to gain added value from currency returns.
The fund started with an experimental program two years ago using three external managers and an internal operation. Sources said that Pareto and Goldman Sachs Asset Management are two of Shell's managers, but neither Shell nor the managers would confirm.
At year-end 1994, Shell had 61% of its 8.4 billion guilder equity portfolio invested outside of the Netherlands and Germany, and 54% of its 3.4 billion guilder real estate investments were outside of Holland. In comparison, it has less exposure to currency volatility from its bond holdings. Only 36% of the 4.3 billion guilder portfolio was invested outside of Holland and Germany.
Officials from Shell say the hedging helped reduce losses last year. Less than 50% of the fund's foreign currency exposure is hedged.
Some Dutch funds hedge currency internally. For example, the 18 billion guilder ($10.8 billion) Pension Fund for Metal Working, Pipe, Mechanical and Automotive Trades, Rijswijk, hedges currency both on a strategic and tactical basis.
One-third of the fund is invested in overseas securities.
On a strategic basis, fund officials have completely hedged their yen exposure, but usually keep other currency exposures unhedged, making other shifts on a tactical basis.