Following a 30% fall in the value of the dollar in recent months, currency managers are demonstrating their ability to beat their benchmark and add significant value to a portfolio
The importance of managing currency within the context of an overall portfolio has raised its profile recently amid the sharp decline of the dollar.
The combination of these two effects has demonstrated that currency management can add significant value within a securities portfolio and this is attracting strong interest among intermediaries and investors.
Key decisions
In terms of currency management within a securities portfolio, there are three key decisions to make.
First, is the strategic decision, or policy mix within a portfolio. For example, when buying foreign securities, it is important to ask whether you would buy them on a hedged or unhedged basis. Appetite to risk is the main determinant to this factor.
There is no right or wrong answer but the risk averse are more likely to hedge against currency exposure.
The second decision applies to whether to deviate from the benchmark hedging policy. This involves forecasting the direction in which currencies are likely to move. David Buckle, currency specialist at MLIM, recommends that active management is something everyone should consider having in their portfolios regardless of the benchmark selected. While currency management is popular in international fixed interest portfolios, it is less commonplace in equity funds.
He says: If you wanted to opt for this route, you would invest in a fund that utilises currency management, or employ a currency manager to introduce such an overlay. Therefore, you would gain exposure to a certain currency that was thought to appreciate and vice versa."
This need not be considered a higher risk strategy. For example, a currency manager would put hedging in place if they were negative on the prospects of a particular currency and, in that sense, risk is being reduced.
Buckle adds: "A key part of this concept is looking at currencies totally independently of securities. Therefore the fund manager would take a view on a particular security or country, so would choose to buy equities or fixed income within that country. By managing the currency alongside that, the investor would not be forced to take a certain currency exposure."
It is possible to hedge away any currency exposure the fund manager creates but does not want. For example, a fund manager may like Japanese stocks but be negative on the yen. Such a manager could buy Japanese stocks but hedge away the local currency exposure.
The third policy decision is to determine who is responsible for these decisions. There is the option of using some sort of currency specialist, or rather leaving the decision to the managers of the underlying securities. The currency specialist would look at the portfolio after all inventories have been bought or sold and adjust the currency exposure accordingly.
Buckle says: "As a currency specialist, my job at MLIM is to look at the individual currency exposures of the securities portfolio and recommend the appropriate currency position. Currently, for example, the stance at MLIM is to sell dollars while positive on the euro and sterling, independent of the country allocation of the MLIM fund range."
Hedging strategies and currency sensitivity of individual companies
Individual companies, which can participate in import and export activities, can have a share price that is sensitive to the exchange rate. Sony, for example, is based in Japan but exports most of its goods so is sensitive to foreign exchange rates.
But while individual companies may be sensitive to currency movements, this sensitivity is less pronounced in the context of an overall portfolio. Taking Japan and Sony as an example, there are a number of importing companies that have exactly the opposite effect, so the Nikkei index has a far lower sensitivity to the yen. A company that has a large sensitivity to foreign currency may be doing its own hedging to try to minimise risk to its books. It is not always clear what the impact of the exchange rate is on a particular security.
Retail currency management
The importance of currency management is well recognised among institutional mandates but is not fully exploited in the retail space. At the institutional level, with large company pension schemes, for instance, there is a large and thriving currency overlay community.
These currency managers are not concerned about the individual securities on the portfolio. Rather, they are primarily concerned about the currency and, as a separate activity, they buy and sell currencies that are added to the fund and packaged up at the total portfolio level. This industry exists because it is recognised in general that not all equity managers are also good at managing currency.
Certainly, currency management is far more commonplace among fixed interest portfolios than equity funds. Buckle says: "Where permitted, all of MLIM's global fixed income funds have currency management applied to it across the whole portfolio in both the retail and institutional space."
key points
Currency management is an established way of adding performance in institutional funds but not in retail portfolios.
Not all equity managers are good at managing currencies.
