The average volatility of the Aussie dollar versus the greenback since 1985, after the dollar settled down following its 1983 float has been 11.6 per cent, which is quite high, according to Ed Smith, senior consultant at Frontier Investment Consulting. It compares with the typical volatility of Australian equities of between 15-18 per cent. Smith echoes Miller’s view that when investing from a high interest rate currency can have a negative expected return (equivalent to saying ‘currency hedging back to high interest rate countries has a positive expected return’). However, currency has substantial diversification benefits that can help in overall portfolio performance, as amply demonstrated over the last year. One of the problems facing currency managers, as well as funds, is that even if they believe they can earn a return from currency, currencies can spend years being a significant distance from true value. Steven Carew, head of investment research for JANA Investment Consulting, said that while there was some return, volatility was “enormous”, so it came down to a risk management issue.

“It comes down to the goals of each individual client,” he said. “You should have the exposure you’re comfortable with, but move away from that from time to time when valuations move.” Acti ve or pasi ve? Funds need to be aware of the two types of active management when considering the active versus passive issue with currencies: alpha-seeking strategies and risk-reducing strategies. About one-in-four super funds is using an active currency overlay. Many investors had believed that if their base currency was weak, then they did not need to hedge. But the events of last year have meant that most investors are now concerned about the US dollar. “Even in the US, they’re worried,” said Ron Liesching, the chairman of US-based currency and commodities manager Mountain Pacific Group. NAB’s conference audience was asked: ‘in the role of an active currency manager, what is the most important – a) to add returns, b) to protect downside risk, c) both, but risk management is more important, or d) both, but added return is more important. A total of 52 per cent of respondents said ‘c’ and 24 per cent said ‘d’.

But whether the decision is active or passive, currency risk is inescapable. “It has a larger impact on performance than all active alpha programs,” Liesching said. James Coleman, senior vice president of Pareto Partners, based in Australia, said it was not possible to remove all risks with a passive hedge. “You can remove performance risk by fully hedging or you can remove cashflow risk (having to top up a hedged position with cash) by not hedging,” he said. “But you can’t do both.” Industry funds, which tended to be concerned about peer risk, most often had hedges of 30-40 per cent. Most consultants advised 50 per cent but the problem with this position was that it always guaranteed some regret. “We can take a policy which trades off the risks, but we can’t minimise them all,” Coleman said. Funds with a high exposure to alternatives had a different view of currency than other funds.