Global institutional investors are poised to hedge their currency risk in the face of dramatically increased volatility in the foreign-exchange market, experts say.
“What we have been seeing more recently is people asking about hedging,” said Diane Miller, principal at Mercer LLC's London office. “We're getting quite a lot of queries.”
Consultants said they have recommended currency hedging for years, but today's environment has heightened investors' concerns about their foreign exchange exposure.
For the year ended Dec. 31, volatility doubled among the Group of Seven currencies, according to the JPMorgan G7 Volatility index. Similarly, a Bloomberg analysis of the G10 currencies shows volatility in the quarter ended Dec. 31 was more than double from a year ago. The pound was hit particularly hard, losing 36% and 30% to the dollar and euro, respectively.
“At the present time, (the interest in currency risk) has probably pegged up one or two notches,” said Matthew Roberts, a London-based investment consultant at Watson Wyatt Worldwide. “A number of our clients have shown an interest in their currency risk in recent months” because of the increased volatility.
Said Joachim Alpen, global head of currency at merchant bank SEB AB, Stockholm: “The massive increase in volatility has certainly made people more aware of currency risk.”
“It's very hard for anyone to neglect (hedging),” Mr. Alpen said.
A recent survey of corporate treasurers by JPMorgan Asset Management indicated that 43% of respondents said foreign exchange risk was a key concern in cash management for 2008, up from just 6% a year earlier. Currency risk was the top concern, edging out the credit crisis.
“This is clearly a reflection of the dramatic currency movements witnessed in recent months and also the extreme uncertainty over global interest rates seen in the summer of 2008, when central banks seemed to be treading the finest of paths between the devil of higher inflation on one side and the deep blue sea of slowing growth on the other,” Kathleen Hughes, head of global liquidity for Europe, the Middle East and Africa at JPMorgan Asset Management, said in a news release accompanying the survey results.
Mr. Alpen said global equity investors used to be able to justify not hedging their portfolios because performance in local currency terms would often make up for any foreign currency moves. “That argument is very hard to make today, when you have large and erratic movements in all asset classes, including FX (foreign exchange),” he said.
A large Swiss public pension fund is moving to hedge all of its foreign currency investments, which created a $1 billion net inflow for passive hedging strategies to Record PLC, London, in the fourth quarter. “The funded public schemes (in Europe) are taking risk reduction very seriously,” said Neil Record, chairman and CEO of the eponymous currency management company. He would not identify the Swiss fund.
Record also has been selected by two U.S. public pension fund clients for active currency hedging mandates worth a combined $5 billion, pending contract completion. Active hedging varies risk reduction on currencies to allow the investor to gain from beneficial foreign exchange movements and adds approximately 100 basis points to returns, Mr. Record said.
The $11.5 billion Kentucky Retirement Systems, Frankfort, is one of Record's new clients, said Adam Tosh, the fund's chief investment officer. The move was made as part of a “modernization” of the fund and as a response to heightened volatility, Mr. Tosh said.
“We had been naked to currency for a long time,” he said. “We didn't want to be in a situation where (international equity managers were doing well) and lose that to currency.”