The strengthening U.S. dollar, diverging central bank policy and a continued search for returns have pension fund executives grappling with both sides of the coin when it comes to currency.
On one side, U.S. pension plans are losing out when they convert overseas investment returns, given the strength of the dollar.
On the flip side, pension plans across the globe are questioning whether they should be taking advantage of the alpha opportunity presented by volatile currency markets as central banks in the U.S., U.K., Japan, Europe and China move down diverging policy paths.
“Many plan sponsors are not comfortable simply passively hedging all of their currency exposure,” said Sean Ealy, director of investment manager research, principal, at RVK Inc. in Portland, Ore. “We see more interest in dynamic hedging and alpha strategies as a complement to a passive hedging program. Performance of the primary holding certainly is the key driver of performance, but the currency decision has an impact, particularly in the short term.”
Data from eVestment LLC show currency overlay managers have been popular in 2015. Net inflows were $3.6 billion in 2015 through June 30, vs. full-year 2014 net outflows of $682.2 million.
Last month, Kansas Public Employees Retirement System, Topeka, launched a search for a currency overlay manager to cover about $1.8 billion in international developed markets currency exposure. The new manager will complement the $16 billion pension fund's existing currency manager, Insight Pareto, whose overlay program will increase to about $1.8 billion, from $1 billion.
In April, the $45.8 billion Teachers' Retirement System of the State of Illinois, Springfield, issued an RFP for managers to provide currency management, and potentially to “identify opportunities to generate alpha through currency exposure,” the RFP said.
Others are grappling with the resurgence in volatility within currency markets, and the strong dollar. A spokesman for the Ohio Police & Fire Pension Fund, Columbus, which has $14.8 billion in assets, said in an e-mail that the pension fund has no currency hedge in place, but executives there are “considering” it. Executives are debating whether currency could be used to generate alpha, but are “leaning toward the view that currency risk should be our focus,” the spokesman wrote.
Not everyone shares the view that currency hedging is necessary, for U.S. clients at least. In a recent white paper, investment consultant Rocaton Investment Advisors of Norwalk, Conn., questioned whether currency hedging made a real difference to U.S. client portfolios.
“For the vast majority, hedging currency does not actually reduce overall risk by that much,” said Matt Maleri, partner, asset allocation, in an interview. “Where they get currency risk is primarily non-U.S. equity portfolios, and there is not a lot of benefit from hedging out the currency, as most of our clients have between 20% and 30% in non-U.S. markets. That currency hedge doesn't move the needle too much,” he said.