In our previous blog, we looked at some of the options available to help you manage your pension fund’s exposure to currency volatility. In particular, we looked at the merits of using a non-hedged share class coupled with an overlay strategy. But in some respects, the example we provided was a little too simplistic. Indeed, in the real world, rather than one (pooled) fund investment, hedged or unhedged, the vast majority of pension funds have multiple (pooled) fund investments. So, it’s a little more complicated than we suggested previously.
In this blog, we dig a little deeper into how you can structure your portfolio more efficiently with regards to mitigating foreign currency exposure, illustrating our points with a real-life example from one of our clients.
05 Apr 2019
As we outlined in our earlier blog, many pension funds invest alongside others via pooled vehicles/funds, managed by an investment management firm. Of course, there’s nothing wrong with this - it’s a widely accepted practice, particularly for local government pension schemes (LGPS) - but you may be limiting your options, especially if you are in a hedged share class, where the currency hedge percentage and strategy is decided by the manager rather than by you.
And to go back to our previous example in blog number three, where we had one pooled investment in a hedged share class, think how much more complicated it becomes if you have not one, but three separate investments in the hedged share class. The complexity increases three-fold, especially when a hedged share class is not hedged in the same way it’s laid out in your hedging policy. By opting for an unhedged share class in a pooled investment, however, you can have more control and greater autonomy over your hedging strategy and you are able to implement a hedge completely in line with your hedging policy. The following illustrates this with a real life example.
UK corporate Pension Fund XYZ
Pooled fund 1 (MSCI World)
Pooled Fund 2 (UK + EU government bonds)
Pooled fund 3 (Global Credits)
Hedge 60% of the total USD, JPY and EUR exposure
No separate hedge strategy for Equity vs Fixed Income
Hedging bandwidth of 2.5% with a monthly exposure review
As the real life example above shows, the pension fund is not compliant with its own hedging policy as the hedges that are included in the hedged share classes are unable to provide the correct hedge, even when taking the bandwidth into account. Furthermore, as the details of the hedge are set by the investment manager of the fund, there is no flexibility for the pension fund to hedge its foreign currency exposure based on the its own risk profile (and hedging policy). Additionally, the currency hedging for this fund now consists of seven currency forwards, with multiple currency forwards per currency.
However, if you choose to invest in the non hedged share class and have a separate currency hedge on the aggregate exposure, the hedging can not only be fully tailored to the risk profile (hedging policy) of the fund, but also the overlay can be more efficient as only three currency forwards are needed (ie the minimum).
Taking back control
We can see from the above example that a separate overlay solution, which is not part of a pooled investment, can provide you with more efficiency and greater control over your currency risk. It also offers you cost efficiencies because it uses a single currency hedge based on the aggregate currency exposure of your entire portfolio. Indeed, our internal research suggests that this approach can achieve cost savings of up to 10 basis points a year.
Via our KASHedge platform, we can provide a bespoke and tailored currency overlay service for pension schemes of all shapes and sizes, based on the their full aggregate currency exposure. This includes giving you access to a Straight Through Processing (STP) solution that provides you with seamless integration between the fund accounting systems and the treasury platforms of the bank.
In the UK, where pension funds are increasingly required to demonstrate the very highest governance standards and reporting ability, an automated STP overlay via KASHedge could be the answer.