Dutch pension funds should consider increasing their dollar hedging, recommends Sprenkels, a Dutch pension consultancy. The reasons for this are twofold: on the one hand, there is a need to protect funding ratios, on the other, there’s the possible impact of Donald Trump’s administration policies.
“The dollar’s safe-haven status must now be called into question. There is more uncertainty than ever about the role of the US as a reliable partner now,” notes Sprenkels’ Pim Zomerdijk. The consultancy recently published a newsletter in which it describes the possible consequences of the Trump administration’s policies.
According to Sprenkels, a scenario in which the US turns away from its current partners and NATO, causing uncertainty among consumers, businesses and investors, will lead to lower confidence in the dollar as the world’s reserve currency.
“In this scenario, more global trade will take place outside America and the dollar and more foreign investment capital will flow into Europe. On balance, we assume this will lead to an appreciation of the euro versus the dollar,” according to the consultant.
Dollar under pressure
The value of the dollar has fallen by some 5% since Trump’s inauguration on 20 January as US president, to approximately $1.08 per euro now. However, according to the Federal reserve’s dollar index, which compares the value of the dollar to other international currencies, the greenback still sits close to its highest level since 2006.
But there are not many reasons to expect the dollar to remain this strong, according to Aaron Hurd, a currency strategist at State Street. “The dollar may rise temporarily in response to the expected tariffs, but in the medium term we expect a euro/dollar rate of $1.20 to $1.25,” he says.
Trump’s actions have damaged US credibility, and foreign investors will start to avoid the country, Hurd believes. “Moreover, countries affected by tariffs will start trading more with each other in response, and as a consequence will also need fewer dollars,” he adds.
Additionally, the fact that most investors are overweight the US, combined with the fact that US investors are underweight the rest of the world, makes it more likely that in the event of a crisis, the dollar will no longer be the safe haven it once was.
“The euro will be the most likely safe haven, together with the Swiss franc, as money will flow back to Europe in case of a crisis. Additionally, two factors that have kept the dollar strong now both seem to be reversing.
“The US is coming off a period of ultra-loose fiscal policy and tight monetary policy, a combination which is good for a currency. Now I expect more rate cuts, combined with fiscal contraction. This reverses the two factors that have pushed up the dollar,” Hurd says.
Currency risk
The resulting sharp increase in perceived dollar risk is especially relevant for Dutch pension funds that are about to switch to a new defined contribution (DC) arrangement and, therefore, want to protect their funding levels. Dutch pension funds invest approximately €300bn in US equities, according to figures from pension regulator DNB, and they usually only partially hedge the currency risk involved. This makes them vulnerable to a sharp fall in the dollar.
Most pension funds have already increased their interest rate hedges to protect funding levels and are also thinking hard about reducing their equity risk. Currency risk has so far been less on the radar, but this is rapidly changing since Trump took office, notes Martijn Euverman, a partner at Sprenkels.
“A number of clients have already increased their dollar hedging,” he continues. Protecting funding ratios was not the only reason for this. “Increasing the dollar hedge would also be on the table without the pension changes. The dollar shock is a risk for the next two to three years. In the longer term, the hedge can be unwound again.”
State Street’s Hurd also advises investors to increase their hedges. He says: “On average, our European clients hedge 30% to 50% of their dollar risk. I would definitely double that ratio now, to above 80%.”
Columbia Threadneedle Investments, a fiduciary manager, has also started to receive questions from pension fund clients concerned about dollar risk.
“Indeed there is greater dollar risk now than before. The status of the dollar as the world’s reserve currency has been called into question,” says Jitzes Noorman, who advises Columbia Threadneedle’s fiduciary clients on their investment policies.
Minor risk
But the threat of a dollar crash for pension funds should not be exaggerated, Noorman adds. “The dominant risks for pension funds are interest rate risk and equity risk. Moreover, most pension funds already largely hedge their currency risk: for nominal investments (bonds) it is almost always 100% and for equities it is generally at least 50%.”
Peter Spijkman, investment strategist at Aegon Asset Management, agrees with Noorman.
“Currency risk makes a smaller contribution to the overall funding ratio risk of pension funds. This is also evidenced by the relatively limited impact of the recent fall in the dollar on funding ratios. As far as we are concerned, it’s therefore not necessary to adjust dollar hedging,” says Spijkman.
Most pension funds indeed have no plans as yet to adjust their currency hedging at the moment. Some funds have even revised their dollar hedging downwards. Such as the civil service scheme ABP, which has halved its dollar hedge on equities from 50% to 25%.
ABP would not say whether it is now considering raising that hedge again because of Trump.
“Due to market sensitivity, we do not comment on our policy on dollar hedging or funding ratio protection,” a spokesperson commented.
This article was first published on Pensioen Pro, IPE’s Dutch sister publication.
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