Many super funds had to write out big cheques last year. They needed to cover their currency hedging positions over international assets as the Aussie dollar tumbled from near parity with the US to around 60c at its low point. As a result, and notwithstanding a subsequent recovery in the $A, future defensive strategies are being explored.
National Australia Bank recently held a one-day conference for super funds and managers to debate various aspects of the currency dilemma.
GREG BRIGHT reports.
Troy Rieck hates the word ‘unprecedented’. The managing director, Capital Markets, for Queensland Investment Corporation says that crises come along all the time. And, for the most part, Australia is, indeed, the lucky country.
But what makes the crisis of the past 18 months different is not so much its severity – because it is not as severe as the 1930s or even the 1970s – but the fact that so many people have so much invested in the markets.
With superannuation at negligible levels in those two previous crises and well before the big government privatisations and floats which spawned stock market investing by average workers, the slump in both listed and unlisted markets, including housing, is much more of an issue this time around.
“It’s a gut-wrenching experience,” Rieck told NAB’s FX Super Funds Conference in Melbourne on August 27. QIC, along with other big funds with large international exposures, suffered calls of hundreds of millions dollars – the so-called cashflow risk of currency – to cover their hedges. And Rieck pointed out that with any crisis, you never quite know when it is over.
Generally speaking, Australia has more room to move than our competitors, with bond yields higher than most countries, a current account deficit which is lower than in the US and an exchange rate “that’s doing its job”.
“But what happens if our luck runs out?” Rieck asked.
About 100 senior fund representatives, consultants and managers were present at the inaugural conference to dissect the issues surrounding foreign exchange. The major themes were: whether or not to hedge, and if so by how much, and whether an active or passive approach is better. The only sure thing is that if super funds have any international assets, they have to form a view on currency. They cannot ignore it. However, annoyingly, there is no optimum single benchmark for them to choose.
To put the importance of the currency decision into perspective, if an Australian fund invested in the MSCI World Index over 2008 was 100 per cent hedged it would have returned a positive 3.5 per cent. If it was 100 per cent unhedged, it would have returned a positive 22 per cent. That would have been the difference between making it a top-quartile fund or a bottom-quartile one.
Leigh Watson, executive general manager, Asset Servicing, for NAB, said that currency was one of the most important issues facing super funds and many funds managers, which has been highlighted by the events of the past year or so.
The biannual NAB Superannuation FX survey of super funds’ attitudes to currency management and aggregate positions shows that the most important change among funds is that they tend to be adopting a total portfolio approach to what they hedge, rather than having separate currency benchmarks for each asset class.
Another trend is a recent swing back to active currency management, which peaked in the late 1990s and fell away after the technology bubble burst (see separate survey report: page 17).
Steve Merlicek, the former chief in- vestment officer for Telstra Super, who last month resigned to move to funds manager IOOF, said Telstra Super had been using a dynamic currency overlay, managed by Pareto Partners, for about 10 years.
“It means our losses have usually been not that bad and we have received most of the gains,” he said.
Telstra Super also has a passive hedge, through National Australia Bank’s Asset Servicing, for 50 per cent over its international alternatives.
It has historically hedged separately by asset class but was looking at a port- folio approach, Merlicek said. The fund was also looking at using option-based strategies to enhance returns.
To Hedge or Not to Hedge
On the question of whether or not to hedge, currency had the potential for risk and return and so should be evaluated in the same way as any asset exposure, Graeme Miller, the head of investment consulting for Watson Wyatt, said.
“Watson Wyatt has a view, which is somewhat controversial, that Australian interest rates are persistently higher … so the carry trade will persist (borrowing in lower interest rate countries, such as Japan or USA, and lending in higher rate countries like Australia),” he said. “But there are diversification benefits. A currency hedge can act as a powerful diversifier, especially in stressed times, and this alone makes hedging very attractive. In times of stress, the correlation spikes to negative one for currency.”
Miller asked whether a super fund could afford to have a currency hedge which was radically different to its peers.
“We find that peer considerations push organizations to have a greater hedging position than they otherwise would have,” he said.
The currency hedging decision is often the most difficult for an investment committee or consultant to put to a board because of its binary nature – you can plainly see at the end of the year whether or not your decision was correct. As a result, many funds opt for a 50:50 hedge ratio to, rightly or wrongly, avoid regret.
In terms of short-to-medium-term opportunities, Watson Wyatt believes that emerging market currencies are undervalued compared with developed market currencies.
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