Trustees of U.K. defined contribution plans should consider implementing a stand-alone currency hedging strategy that takes advantage of the pound's position against other major currencies, sources said.
While a number of defined benefit funds already apply strategic currency hedging to protect against currency fluctuations, many DC plans do not have such positions in place, sources said. Instead, trustees rely on their equity money managers to hedge portfolios on their behalf.
But the case for a stand-alone currency hedging program is more relevant now than ever, sources said, for several key reasons.
The fact that DC plans are much larger in size, following the success of automatic enrollment in the U.K., is a factor in favor of a stand-alone program because the plans now have the scale and the skills to engage in a more sophisticated investment practice. U.K. DC plans count some 14.8 million members, according to The Pensions Regulator's 2016 data. The workplace DC market was £351 billion ($432 billion) at the end of 2016, according to research firm Spence Johnson.
The pound sterling's recovery in recent months, particularly apparent since British Prime Minister Theresa May announced last month that the U.K. general election would be held June 8, is another key factor.
Since the Brexit vote in June 2016 through May 24, the U.S. dollar has risen about 12% against the pound. But in the last eight weeks, the pound traded up 3.2% against the dollar, hitting a two-month high at $1.30 on May 25.
Although sterling remains low, there is no particular reason to think this is likely to continue, said Charles Goodman, head of business development at London-based Millennium Global, a currency management firm. “We would expect to see a wide variety of environments in the coming years, as we have done in the past,” Mr. Goodman added.
The U.K. currency's rebound seems to have prompted investors to revive hedging strategies, even causing some trustee-directed DC funds to overhaul their currency policies.
“There is 5% to 10% more demand for currency hedging from DC plans recently compared to previous years,” Joanna Sharples, investment principal at Aon Hewitt in London, said in an interview.
Trustees can implement active currency hedging programs as an overlay with the help of specialist currency manager or request their equity managers to provide it in the default fund.
Robert Bennett, senior manager, pensions investments at Siemens U.K., which implemented a currency hedging program in April for its DC plan, the £1.3 billion ($1.7 billion) Siemens Investor Plan, Camberley, England, said: “Our main focus when redesigning the DC investment strategy was our members, in particular, mitigating the risks they face when saving for retirement. The risks that overseas currencies can introduce for DC savers are often overlooked. We ensured that this wasn't the case for our members by carefully considering the risk and return trade-off and then implementing a currency hedging strategy that we believe will improve the investment experience of our members.”
There are practical challenges to developing currency hedging strategies for some DC retirement arrangements — one being the issue of beneficial ownership.
Where a sponsoring employer takes responsibility for the plan, like it would in a DB plan, it would likely be easier for to implement a strategic program, said James Wood-Collins, CEO of Record Currency Management based in Windsor, England. “But where the responsibility sits with an employee, it will be much harder to do it” because such action is not taken collectively.
The justification for additional fees is another challenge. Additional management costs for currency hedging a global equity investment range from 0.02% to 0.06% per annum, according to a recent paper from Aon Hewitt, “Does Currency Hedging Matter in DC?”