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International

Asian pension funds get aggressive on currency

Larger overseas allocations, volatility behind fund moves

Adeline Tan
Adeline Tan thinks currency market volatility has made the impact currencies can have on a portfolio a key point in performance monitoring.

Asia's largest pension funds might be moving to adopt more dynamic currency strategies in response to growing overseas allocations and greater foreign-exchange market volatility.

Executives with Japan's Government Pension Investment Fund, Tokyo, the world's biggest with 135.1 trillion ($1.1 trillion) in assets, said in early December that the fund was prepared to hedge its 35% allocation to overseas stocks and bonds should the yen appear poised to rebound against the dollar and the euro.

Three years before — when Shinzo Abe swept to power as prime minister on the promise of reviving the Japanese economy, in part by shifting the GPIF to higher-risk assets from Japanese government bonds — less than 23% of the fund's portfolio was invested abroad.

The yen has depreciated 35% against the dollar over that period.

Meanwhile, market veterans, who declined to be named, said Asia's second largest pension fund, South Korea's 507 trillion won ($426.4 billion) National Pension Service, is considering putting a dynamic currency overlay in place to manage the currency exposure of the fund's 23.6% allocation to overseas assets as of Oct. 31.

Asked whether a more flexible currency overlay program could be in the offing at NPS, a Seoul-based spokesman for the fund said in an e-mail, “it could be.”

In late December, Korea's Ministry of Health and Welfare, which oversees the fund, announced NPS' 100% hedge of its 4.2%, or $18 billion, allocation to foreign bonds would be gradually reduced to zero by 2018.

The fund already had reduced a 50% hedge on its allocations to foreign equities and alternatives to zero between 2009 and 2014 — a move that benefited NPS over the past two years as the dollar was strengthening against the won.

As of Oct. 31, the fund held 13.4% of its portfolio, or $57.3 billion, in foreign equities, and 6%, or $25.1 billion, in overseas alternatives — mostly real estate.

Money managers in the region, who declined to be named, said those moves might prove to be a matter of replacing the fund's set-in-stone hedge ratio with a more dynamic overlay.

Meanwhile, a GPIF spokesman said in an e-mail that the Japanese fund's external managers previously “hedged their assets as necessary” but this would be the first time the GPIF itself has prepared to hedge its foreign assets.

The spokesman declined to say whether GPIF already has begun hedging, in order to “avoid influencing the market.”

For asset owners in Asia, not hedging their overseas allocations has been the right choice in recent years as the dollar strengthened.

Institutional investors in the region who were unhedged “have done great,” said Ugo Lancioni, a London-based managing director and head of currency management with Neuberger Berman LLC, in an interview.

For example, the GPIF reported a 22% return on its international stock allocations for the 12 months ended March 31, 2015 — a period when the MSCI All Country World index rose roughly 3%, while the yen fell 16% against the dollar.

Whether an inflexion point is approaching is an open question.

U.S. dollar upside

Mr. Lancioni said the dollar has “a bit more upside ... but I don't think (we'll see) another 10% move” from here, as the deflationary impact on the U.S. economy of the greenback's continued rise would become increasingly problematic for policymakers at the Federal Reserve.

Adrian F. Lee, president and chief investment officer of London-based currency manager Adrian Lee & Partners, said he sees room for Asian currencies to continue weakening, with China's ongoing move to allow its renminbi to weaken adding to that downward pressure. It's hard to see why most institutional investors in Asia would want to start hedging at this point, he said.

On Jan. 7, BlackRock (BLK) Inc. (BLK) launched three “adaptive currency-hedged MSCI” exchange-traded funds to help U.S. investors thread that needle. That same day, New York-based WisdomTree Investments Inc. launched its “dynamic currency hedged international equity” ETFs.

In a news release, Heidi Richardson, BlackRock's head of investment strategy for U.S. iShares in San Francisco, predicted continued dollar strength this year. But with “bumps along the road” likely, U.S. investors might want to consider “a flexible approach to hedging currency risk,” she said.

Likewise, the pickup in foreign exchange market volatility has heightened interest among Asian asset owners in the impact of currency fluctuations on returns, even if the growth in the number of mandates for hedging or alpha-focused currency strategies has been incremental, currency managers and analysts say.

The spike in currency market volatility has left clients “more alive to the impact of currencies on their portfolios,” and the topic has become a key discussion point in performance monitoring, said Adeline Tan, a senior consultant and Hong Kong-based head of investment advisory with Mercer Investments.

That heightened volatility has led to a pickup in interest in actively managing currency risk, agreed Mirza Baig, Singapore-based head of foreign exchange and interest rates, Asia, with BNP Paribas.

Mr. Baig said even within the universe of asset owners in the region, however, behemoths such as GPIF and NPS stand out, as their weights in their respective economies find them being drafted to contribute to broader government goals.

To some degree, GPIF was induced to “support the whole project of Abenomics,” while the push of both funds in boosting offshore allocations has been supportive of the Japanese and Korean governments' goals of weakening their respective currencies, he said.

If GPIF and NPS do put more dynamic hedging policies in place, they could add an Asian element to a trend currency managers predict will pick up steam in coming years in Europe and North America, where the bulk of hedging mandates have remained passive.

Dynamic hedging

Mr. Lancioni said Neuberger Berman's roughly $20 billion currency business now is composed of $15 billion of hedging solutions, mostly passive, and $4.5 billion of alpha-focused products, employing a portable alpha structure.

While dynamic hedging accounts for only a sliver of that $15 billion total, Mr. Lancioni said conversations with a number of large institutional investors in the U.S., Europe and Australia have led him to believe that dynamic hedging “will be the bulk of our business in a few years.”

That reflects the recent experience of investors, with a number of European asset owners — hedged to deal with a euro that until recently seemed overvalued — losing out on the potential gains dollar exposure would have given them, even as mostly unhedged U.S. institutional investors suffered as the dollar's surge cut into the value of their overseas holdings, he said.

Analysts and currency managers say more asset owners in Asia could follow if the GPIF and NPS lead, with Mr. Baig singling out the Japanese giant's status as a role model in Asia's biggest institutional marketplace.

James Wood-Collins, CEO of London-based currency manager Record PLC, said while the core markets for his firm's $53 billion under management have been the U.K., continental Europe and North America, it is building an Australian and New Zealand client base now, in tandem with a local partner, and getting a growing number of calls from large pension funds and sovereign wealth funds in Japan, Korea, Singapore and China.

For now, Record has one Singapore-based client, said Mr. Wood-Collins. He declined to identify the client.

This article originally appeared in the January 11, 2016 print issue as, "Asian funds get aggressive on currency".