The falling U.S. dollar is making pension funds that don't hedge their international exposure - including the Florida State Board of Administration, Teachers' Retirement System of the State of Illinois and the Montgomery County (Md.) Employees' Retirement System - look very smart.
The $88 billion Florida State Board of Administration, Tallahassee, which has about $12 billion in international equities, only lets its international money managers hedge opportunistically.
"We primarily use hedging as a risk-control measure, not for value added," said Scott Seery, Florida's director of international investments. "Some managers use hedging to control risk and hold themselves closer to the benchmark."
Clearly, those who don't hedge are in the majority. Only $100 billion to $200 billion is in currency overlay strategies, even though about $2 trillion is benchmarked to the Morgan Stanley Capital International Europe Australasia Far East index, said Doyle Levanoni, manager of currency research at First Quadrant LP, Pasadena, Calif. His firm has $2.25 billion in currencies under management.
"We don't see a big benefit from hedging," said Patrick Bell, chief investment officer of the $1.7 billion Montgomery County pension fund, Rockville, Md. "Our managers have the ability to do currency hedging opportunistically. I don't see the need for us to set up a separate overlay program now."
The Illinois Teachers system, Springfield, used a currency overlay program several years ago but discontinued it because "we weren't satisfied with the execution," said John Day, a spokesman for the $22.8 billion fund.
The fund is doing a study to determine if it will adopt a currency overlay strategy again or continue to have its international managers hedge opportunistically.
"We've had some discussions about what to do going forward," said Charles Self, chief investment officer. "We don't take a look at the dollar on a short-term basis. Whatever view we take, it will be for the long term."
"If we do decide to take on currency risk, we'll have to see what risk-return profile we want," said Mr. Self.
Supporters speak up
Some plan sponsors clearly believe in hedging their currency risk. William F. Quinn, president of AMR Investment Services Inc., Fort Worth, Texas, which runs the $11 billion American Airlines pension fund, is one of them.
"We think we can get incremental return and it reduces risk" in the international portfolio, said Mr. Quinn. He believes currency overlay can add value even when the dollar weakens, which boosts the returns on investments in currencies such as the euro, which are strengthening against the dollar.
American uses three currency overlay managers - Bridgewater Associates Inc., Westport, Conn.; Bank of New York and J.P. Morgan Fleming Asset Management Inc., both of New York. The managers hedge up to 60% of its $1.8 billion international equities portfolio. "We've added 1.5% in incremental return over the last several years," said Mr. Quinn.
Even some international money managers don't believe in currency hedging. "Our philosophy is when you invest in international equities, you do it for the diversification. You get better diversification from an unhedged benchmark," said Thomas Hancock, a partner at Grantham Mayo van Otterloo & Co. LLC, Boston.
Although GMO hedges opportunistically, now is not the time, Mr. Hancock said. "We think the dollar is overvalued, which could have positive implications for unhedged portfolios."
GE Asset Management Inc., Stamford, Conn., also does not hedge its international equities portfolios.
"Hedging is expensive and introduces an element of market timing that takes away from the pure bottom-up (investment) process" the firm follows, said Jonathan Passmore, senior vice president and portfolio manager for international equities. "Market timing and momentum investing are as far away from our process as you can get. The companies we invest in are global in their outlook and have their own hedging strategies. For us to be hedging as well is doubling up on that position."
Moreover, he pointed out, "we have a geographically diverse portfolio. Being underweight or overweight countries is a statement on their currencies. By being overweight investments in the euro, we're making a statement on how we feel about the euro."
But he acknowledged some of the firm's international investing clients use other money managers to provide currency overlay strategies on their international investments.
Sarah Ketterer, portfolio manager at Causeway Capital Management LLC, Los Angeles, said the firm will do currency hedging, but only for pension plans that request it. "I don't think there's an asset class more difficult to predict than currencies."
"If you call currency (movements) wrong, you lose money. Hedges have to be closed out and you could lose money that could be invested in stocks, where your talents lie," she said.
Ms. Ketterer said all currency hedging does is "take some of the volatility out of short-term performance. It takes a clairvoyant manager to consistently make money for clients with hedging."
Not surprisingly, money managers who provide currency hedging and overlay strategies believe they are an effective way to add value to an international portfolio.
"Currencies have an effect on (investment) portfolios. They shouldn't be an accidental bet. They should be managed," said First Quadrant's Mr. Levanoni.