ROUNDTABLE
The 4% return for the UK-based investor would actually have all come from sterling depreciation, not from equity markets. While fortuitous in this instance, taking a punt on sterling might not have been what the investment strategy was designed to target.
In this case, it would have paid off but it may not always. If you were a client of Mercer, we’d probably have advised you to hedge at least some of the currency exposure so as to reduce this source of unwanted volatility. Then you could have used a risk budgeting approach to reduce risk overall or allocate the risk to investments that offer a better expected rate of return than taking passive currency exposure.
JB: Not on average but I would suspect that there is a range of awareness. However, I think that in Australia almost all would have an opinion on where the A$ is going.
0RVW LQYHVWRUV FDQ VHH WKH EHQHÀW RI D SDVVLYH currency hedging policy to mitigate risk. As currencies become more widely accepted as DQ DVVHW FODVV LV WKHUH OLNHO\ WR EH VLJQLÀFDQWO\ increased interest for active overlay strategies that can deliver modest returns and if so, do you see regional variations in demand for these?
KS: 7KH GLIÀFXOW\ ZLWK RYHUOD\ VWUDWHJLHV LV WKDW WKHLU performance has been somewhat patchy. We still don’t have a long enough track record to say with VWDWLVWLFDO VLJQLÀFDQFH ZKHWKHU WKH\ FDQ ZRUN RYHU many different market cycles – they still haven’t been around for long enough – although some managers do seem to have a better track record than others. The credit crunch proved to be a particular problem for quantitative overlay strategies, and many institutional investors withdrew their overlay programmes at this time. That having been said, WKH GHVLUH IRU ULVN GLYHUVLÀFDWLRQ DQG DOSKD UHPDLQV stronger now than ever before.
DM: :H ÀQG LW KHOSV WR WKLQN RI FXUUHQF\ H[SRVXUH as two different types: the strategic currency impact, whether it should be hedged, and if so, by how much; and the active currency opportunity and how this could best be implemented. The ÀUVW LV DOO DERXW UHGXFLQJ risk and the second is about
using risk to add value, or alpha, from active currency management. By considering these two decisions separately, investors are likely to achieve a better result.
Of course, when it then comes to
implementation, it might be more practical to combine them again, or
maybe not. The hedging is usually implemented via an overlay but the alpha generation doesn’t have to be. There do seem to be some regional differences at this stage. Recently, we have seen increased interest in overlay mandates from North American investors and Australian
LQYHVWRUV ZKR ZDQW WR PHHW VSHFLÀF UHTXLUHPHQWV UK investors tend to prefer to invest in absolute return currency funds.
JB: The currency risk is part of international
investments. There has been a huge amount of volatility in the currency markets in the last 4 years. Depending on your base currency, you would have
Autumn 2011 | Currency Investor 59
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