He says super funds with exposure to international investments must have a clearly defined hedging strategy that is carried out efficiently.
“When super funds buy international shares they’re taking on two separate risks: share market volatility and currency exposure,” Bennett explains. “It’s a bit odd to invest offshore and then complain about the currency. That’s just part of the business.” He says some super funds have slung currency in the too-hard basket, going unhedged in the hope exchange-rate volatility will average out over time. While others are taking responsibility for currency management themselves.
“My gut feeling is super funds are not that good at managing currency internally,” Bennett says.
He thinks that if super funds are going to take on the hedging strategies internally, they should either be unhedged or fully and passively hedged.
“Alternatively, they could actively manage the currency exposure themselves, which means that it’s individuals or an investment committee deciding that they are cleverer than the currency markets.” Another option is for super funds to manage equities on an unhedged basis while delegating currency management to specialist funds.
Change in risk response
Despite a certain amount of back-sliding into complacency since the shock of the 2008 financial crisis woke super funds up to the dangers of exchange rate risks, Bennet thinks that the industry is taking currency management more seriously.
“There is a firm trend towards super funds being more active with their currency hedges on a day-to-day basis,” he says.
Danica Hampton, director of currency overlay at National Australia Bank (NAB) wholesale banking division, has also picked up on a post-GFC behavioural change in the way super funds and other institutional investors manage currency.
“The cash-flow impact of hedging came back with a vengeance in 2008,” Hampton says. As a point of reference, in normal times the average cash-flow impact of rolling quarterly forward-currency hedges equates to about 1.6 per cent of the amount hedged. In the wake of the 2008 crisis, cash flows (both in and out) from currency hedges topped 13 per cent.
While investors didn’t necessarily ignore currency risk prior to the crisis, Hampton says the most common approach was to passively hedge – perhaps 50 per cent on international equities and 100 per cent on global fixed income assets.
Cash up: the total portfolio approach
A 2011 NAB survey of super funds’ approaches to currency highlighted just how much the crisis has changed investor behaviour. The NAB report states that almost 60 per cent of large super funds adjusted their hedges in the two years prior to the survey – two-thirds reducing hedges and one-third increasing the amount hedged. Ironically, the net effect of this wholesale shift was negligible, amounting to a change in currency exposure of less than 1 per cent of total super funds under management.
