The precipitous decline in the euro hasn't panicked global bond managers, but many are hedging their bets -- literally.
"The weakness and volatility (of the euro) is calling into question the appropriateness of open currency exposures in any kind of fixed-income portfolio," said Laura Zimmerman, senior vice president at Payden & Rygel in Los Angeles. The firm runs $5 billion in global bonds.
"We've worked closely with clients and consultants to have them consider having more of a hedged mandate," which would shield them from the impact of such a severe currency decline as the euro has sustained.
At TIAA-CREF, New York, which runs almost $4 billion in international bonds, all of the international fixed-income portfolios are hedged, said bond manager Edward Grzylowski.
"We pick a sector of the market that we think is undervalued," Mr. Grzylowski said. "But our policy is then to hedge because we are not attempting to take currency risks. We take credit risks."
That aversion to currency risk has helped some investors who heeded advice to hedge, explained Adnan Akant, managing director of Fischer Francis Trees & Watts, New York, which runs about $16 billion in global and international fixed-income portfolios.
"Many of our pension fund (clients) have fully hedged (their portfolios) vs. the benchmark," said Mr. Akant. "They may have benefited (from owning) euro bonds if they hedged the currency risk."
"As a manager, we can add value (from investing in euro bonds). But we recommend having fully hedged foreign bonds allowing for currency management," he said.
Kareem Basta, senior strategist at Merrill Lynch & Co., New York, also suggests that investors hedge their portfolios.
"In global fixed-income portfolios, the currency decision is most important," Mr. Basta said. "Even if the bond markets yield 5% or 6%, if (investors) got the currency decision wrong, they were overwhelmed by the impact of that decision on their portfolios."
But Mr. Basta and Mr. Akant also recommend underweighting euro-denominated bonds, which represent 30% to 35% of the value of the major bond indexes.
"As an active manager, we've been underweight the euro," said Mr. Akant. "If the euro goes down as sharply as it has, and you are underweighted, it will help your portfolio a lot. As an active manager, our job is to figure out what it (the euro) will do and act on it. We were prepared for the decline and we're still betting in that direction. We think it will go down further."
Staying short with the euro and long on emerging markets currencies has helped portfolios at Julius Baer Investment Management Inc., London. "We've underweighted the euro for quite some time," said Edward Dove, chief investment officer. "The benchmark is euro exposed as well, and we're comfortably up vs. the benchmark." Julius Baer runs approximately $6 billion in international fixed income.
James Mulally, head of fixed-income investing at Capital Guardian Trust Co., Los Angeles, said most of the firm's portfolios have been underweight euro-denominated bonds most of the year but now are leaning toward benchmark weighting, adding, "everyone knows it's currency driven."
While Mr. Mulally doesn't expect the euro to rise much any time soon, "over the long term, over the next few years, there will be a significant overweight of the euro." Even over the "fairly short term," he said it's likely that growth in euroland companies will be stronger than in U.S. companies.
"As capital outflows from euroland dissipate, it will strengthen the euro," said Stuart Hochberg of Fiduciary Trust Co. International, New York. "It's difficult to say when that will happen. That's why we're staying neutral."
But Mr. Hochberg thinks the end of the selloff in the euro could occur "at any time." He said much of the selling pressure now is from Japanese investors ahead of the Sept. 30 end of Japan's fiscal year. "The euro's been very weak against the yen," he pointed out, adding he expects it could weaken further with a "downside risk of 80." Fiduciary runs $13.5 billion in global and international bond portfolios.
From another angle, the euro's decline has presented opportunities to lift some hedges and raise euro exposure, said Michael Goosay, vice president and portfolio manager of GE Asset Management, Stamford, Conn.
While Mr. Goosay thinks the euro may continue to have problems over the long term, "sometimes managers overdo it. With the euro, it was way oversold,"he declared. GE manages a total of $800 million in international bonds.
Patrizio Merciai, chief investment strategist of Lombard Odier Inc., Geneva, also thinks the euro may be a bit oversold. "We expect the euro to test the 90 level (over the short term). At 92, we expect it will stay under some pressure," he said.
By the end of the year, Mr. Merciai predicts the euro will be around 93 to 94 against the dollar. "It would not recover much above the 93 to 94 level on the 12-month horizon," he said. He still expects U.S. bonds will come back strong, limiting any recovery of the euro.
And while he expects the outflow of capital from euroland to the U.S. to shrink, he doesn't think it will be enough to lead to a major appreciation of the euro.
Lombard Odier manages $1 billion in global bond portfolios for U.S. pension funds.