| Currency overlay now a source of alpha for investors |
|
|
| 01/05/2005 | |
|
Pension funds do not snub currency overlay anymore. With double-digit returns on the equity markets something of the past, they are more numerous than ever before to use a currency overlay manager to prop up their returns. Only in April, the £3bn London Pensions Fund Authority and the £2.6bn Tyne and Wear Pension Fund both initiated search for currency overlay managers to extract more returns from their equity portfolios. According to Neil Record, Chairman and Chief executive officer of Record Currency Management, one of UK's oldest currency manager, the penetration rate of currency overlay among UK pension funds currently amounts to 10%, but could rise in the next two year to 40% or 50% as larger funds adopt the strategy. "The market for currency overlay is optimistic structurally as I've ever known it. We've been doing it for the last 20 years and the last 2 years have been much more active than the previous 18", he says. While Record Currency Management, which has $20bn under management, previously had 60% of its clients in the US, it now has them equally split up between the US, the UK and Continental Europe. The highest growth market is the UK, which has been very late in adopting currency overlays. "Our US assets have continue to grow in the last 5 years, but as a proportion they have shrunk, because our assets have grown enormously first in Continental Europe, and more recently over the last 15 months in the UK", observes Neil Record. Asset allocation Two factors are propelling the market: currency risk and alpha generation. Surprisingly enough, most pension funds do not hedge their exposure to foreign currency in international equities, which accounts for an increasing share of their portfolios. However, with currency markets becoming more volatile over the last four years, investors have acknowledged the need to shield their investments from this risk. That's where currency overlay managers -- to which investors can outsource the management of their currency risk and currency value added -- have found their most valuable selling point. Using forward contracts, the currency overlay manager can hedge the investor's currency risk or create pure value added on top of the existing asset allocation. This means that investors can actually boost their returns by playing on currency movements without modifying their actual asset allocation. Alpha generation At this time, Neil Record says that the main reason for using a currency overlay is to get more alpha, which was not the case until two years ago, when a currency overlay was rather seen as a hedging tool. "We typically generate anywhere between 1% and 3% in value added a year. That's all very well, but when equity markets are delivering an average of 12%, our customers simply say that they get their value added out of equities", he says, adding that the currency overlay is not always very well understood. But even if alpha generation has become the most compelling reason for awarding a currency overlay mandate, currency risk hedging usually ends up being included up in the package. "In our experience, a lot of clients in the UK and Continental Europe wrap the two up together. They may recognise that they're two different animals, but because it's all called currency, we'll be hired for a mandate that has both a hedging and an alpha purpose. Yet, we still have clients who just want to do hedging and other clients who just do it for the alpha", says Neil Record. As such, currency overlay mandates are often split up between a hedge in international equity and a currency alpha stream. Investors a market such as the US – whose currency is significantly correlated to a number of non-US equity market – are likely to go for a full alpha generation currency overlay mandate, since hedging is then less valuable. Julien Laplante |
|
Articles of the same Topic : Currencies |
|
© Copyright 2008 bfinance. This document is for your personal non-commercial use. Any further copying, reproduction, distribution is strictly prohibited. To obtain permission please contact This e-mail address is being protected from spam bots, you need JavaScript enabled to view it