| Volatility has turned the spotlight on active currency management |
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| 01/05/2005 | |
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Investors have surfed a wave of currency trading as the global foreign exchange trading volume increased by 25% in 2004, according to Greenwich Associates, a consultancy. For many of them, the sizeable currency ups and downs over the last years have become something not only to take cover from, but also to take profit from through active management. "The changes that are occurring in global FX have been so profound that the market has begun to evolve from its origin as a by-product of international trade and international capital markets transactions to an asset class in itself", says Woody Canaday, a consultant with Greenwich Associates. Currencies have traditionally been seen as a source of risk rather than anything close to an asset class. The impact of currency movements on an overseas investment return can be substantial. For instance, the 50% increase of the S&P 500 in local currency terms from its October 2002 low translated into a mere 11% return in euro and into 22% in sterling. Currency risk-conscious pension schemes cannot generally rely on their overseas equities asset manager for hedging the currency exposure. "We don't have to hedge our portfolio since our benchmark is unhedged. To actually hedge it would be to take a risk relative to the benchmark", explains Jeremy Podger, the manager of Threadneedle Investment's Global Select Growth fund. "If an investor wants to hedge its currency exposure, he can do it himself", he says. From passive to active Now, the joint effect of heightened volatility and low traditional returns are turning currencies into a source of supplementary returns. JPMorgan Fleming revealed in its last survey of UK pension funds' alternative investments that 45% of pension schemes would consider currency management, roughly a third of them as a tool to enhance returns (29%), a quarter (24%) to control risks and about half for both purposes. "Pension funds are now more interested than ever before in active currency management", confirms Neil Record, Chairman and Chief executive officer of Record Currency Management, which was one of the first company to be awarded an active currency management mandate by the Water Authorities Superannuation in 1985. And the pension industry's interest in active currency management is not an exclusively UK phenomenon. Take for instance Austria's APK, a €1.8 billion multi-employer pension fund. "We started using a currency overlay about three years ago to actively manage the currency risk. What we started doing late last year is using active currency strategies as one of our alpha strategies", says Guenther Schiendl, the Head of investments of APK. Opportunities According to most specialists, the massive presence of passive price takers on the $1.9 trillion a day currency market opens the door to profits. Lending support to this observation, a report published by Brian Strange in 1998, showed that 80% of 152 of currency overlay account studied had outperformed their benchmark over the period since their inception. Active currency manager can intervene on the FX market on behalf of investors either through the derivative market or the currency market. For an intervention on the derivative markets, the investor generally awards a currency overlay, which is carried out with derivatives such as futures and forward contracts. Such a strategy allows to leave the actual asset allocation untouched, but can bring along some operational difficulties usually associated with the use of derivatives. Direct intervention on the currency markets will take the form of a cash-plus strategy that ploughs directly in the assets of an investor, reducing the funds to be allocated to the other asset classes. While such a strategy affects the overall asset allocation of a scheme, it does not carry the operational difficulties of using derivatives that can be foreseen by trustees. Pointing to the increased demand for diversified currency management product, traditional currency overlay manager such as Record Currency Management are now stepping on hedge fund managers' turf by launching full-blown currency funds that implement long-short currency strategies. Traditional fund and hedge fund managers, whose traditional strategies have been impaired by the lack of volatility on the equity markets, have been doing the same by launching their own currency funds. It remains to be seen whether currencies will retain their importance once volatility goes back to lower levels. Julien Laplante |
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Articles of the same Topic : Currencies |
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