Currency managers say U.S. institutional investors that hedge some or all of their non-U.S. equity exposure remain a decided minority, but with bearishness on the dollar's outlook giving way to more mixed views, a growing number are revisiting their options.
With the dollar generally declining in value against other major currencies over the past decade, not hedging has been a winning bet for U.S. investors. But increasing overseas allocations and potential gains by the U.S. dollar are prompting some soul searching, observers say.
Currency is the biggest unmanaged risk U.S. investors are taking today, said Max Darnell, chief investment officer of First Quadrant LP, Pasadena, Calif. Currency adds 8% to the volatility of the non-U.S. portion of a plan's portfolio, or roughly half the total volatility, with no expected return, agreed Laurie O'Donoghue, chairman and president of currency manager Pareto New York LLC.
Following the wake-up call in 2008, when safe-haven buying caused the euro to plunge from $1.60 to $1.25 between July and October and more recent dollar strength, State Street Global Advisors' currency strategies “are definitely seeing more interest now” as institutional investors revisit the rationale for hedging, said Alistair Lowe, executive vice president and CIO for SSgA's multiasset class solutions and currency strategies.
The past decade's consensus that the dollar was going to be weak forever has been battered recently, leading to a growing number of “sober” conversations about the place hedging has as a risk management tool in institutional portfolios, Ms. O'Donoghue said.
Even so, demand from U.S. investors remains a fraction of what Pareto is seeing in markets such as Australia, where the firm's business “is going through the roof,” she said. Pareto has garnered two sizable currency hedging mandates from U.S. institutional investors since the start of 2009, with one more yet to be funded — a fairly normal pace of new business, Ms. O'Donoghue said. For the same period, Pareto won 10 new assignments from Australian institutional investors, with another five awaiting final approval or funding, she said. She wouldn't identify the clients.
Pensions & Investments' latest survey of top U.S. pension funds, conducted during the fourth quarter of 2009, showed only 36 of the 200 biggest funds had currency programs. And, many of the 36 were using currency as a source of alpha or absolute returns, rather than for hedging.