SSgA puts some returns spice into currency hedging

State Street Global Advisors (SSgA) has launched a currency management strategy which fits between active and passive hedging for Australian institutional clients.

State Street Global Advisors (SSgA) has launched a currency management strategy which fits between active and passive hedging for Australian institutional clients. Called a ‘dynamic strategic hedging program’, the strategy is an overlay which adjusts the (passive) hedge ratio over the course of a currency cycle, according to currency and interest rate movements which impact on the manager’s model of what constitutes ‘fair value’. The program differs from global active currency management by not involving cross-currency management – movements are expressed in terms of an Australian perspective only. According to Lochiel Crafter, SSgA’s chief investment officer for Asia Pacific, the manager would not be altering its positions monthly, but, more likely, on a 12-monthly basis. It could do so after liaising with the client if requested. “This is about managing returns as well as risk,” he said. “We are trying to talk around the various strategies. There is no single answer.” A common 50 per cent static hedge, where half an offshore portfolio is hedged back to Australian dollars, is often referred to as “the minimum regret” if the currency falls or rises sharply – half the gains or half the losses. Back-testing of the new SSgA strategy, which is based on a model built by the firm several years ago, shows that the dynamic program would have returned 3.2 per cent a year over an 18-5-year simulation, compared with a 50 per cent static hedge return of 1.6 per cent. Volatility for the dynamic hedge, however, was 5.7 per cent against 4.9 per cent for the 50 per cent static hedge over the period. But the percentage of annual negative returns was fractionally lower with the dynamic strategy, at 43.4 per cent against 44.3 per cent for the 50 per cent static hedge. SSgA basis its fair value model on ‘purchasing power parity’ (PPP), which uses inflation, short-term interest rates and actual exchange rates. The theory behind PPP is that similar traded goods, when sold in different countries, should sell for the same price and this price should be reflected in relative exchange rates for different currencies. The strategy was developed by former head of currency and asset allocation in Australia, Lawrie Dryden, who has recently moved to SSgA’s London office. His place has been taken by Chris Loong, a former head of interest rates and currencies for AMP Capital Investors. It was built specifically for a large client which had been using passive hedging strategies previously and wanted a more systematic way to review its hedging ratio.