In recent years it has become increasingly important for pension funds to re-examine how they manage their currency exposures. The trend toward holding ever greater proportions of foreign equities post euro introduction; the move towards multi-manager structures; the search for alternative sources of excess returns and the growing use of risk budgeting – all have major currency implications for European schemes that they are being obliged to act upon.
In Deutsche Bank’s Global Markets Research study ‘A Guide to Currency Overlay Management’, concluded that investors and plan sponsors should consider increasing their focus on both the risk of, and the potential returns from foreign exchange (FX), claiming: “Historical performance data suggest that active management of FX risk can significantly increase alpha”.
The noise has not been lost on Europe’s pension funds.
At the end of 1999, the e4bn Ijmuiden-based pension fund of Dutch steel giant, Hoogovens, began researching whether active currency management would be a viable way of adding value to the fund’s portfolio.
In March 2000, the scheme decided to implement an overlay strategy based on the belief that the currency market was inefficient and encouraged by the performance of currency overlay managers.
To gain as high an information ratio as possible the fund looked to external currency expertise. The currency overlay programme, it was decided, would have its own risk budget and be structured as a long/short programme with long and short positions in currency forwards determined by the fund separately from the currency exposure of its international investments. The fund commenced with a relatively small programme of e300m and took a tracking error target of 2%-4%.
Patrick Bronger senior investment manager at the fund, explains that depending on the market circumstances the Hoogovens fund hedges the currency exposure on its equity investments.
“For example, we have an exposure in the US market and the benchmarks we use are un-hedged, but sometimes we perform hedging transactions in order to increase the investment returns above the benchmark that we use.”
The fund uses two external currency overlay managers, but also carries out some currency management in-house.
Prior to selecting the managers, the fund created a search process that included comparing how pairs of overlay managers produced return and risk profiles that were suitable to Hoogovens’s particular risk preference.
Bronger says the principal application of currency strategies is to add value to the fund returns.
“One of the reasons that we decided to do currency overlay was that there was a lot of research indicating that it was possible to add value by having currency overlay managers. The reason we then selected two external managers was to diminish the risk through using different strategies.”
Risk management, he says, is also another reason why the fund may hedge its equity exposure. “There can be huge correlations between equity moves and currency moves, so in order to diminish the risk for the total portfolio sometimes it is appropriate to carry out hedging transactions.”
For Hoogovens, the policy has worked, as Bronger notes: “All of the managers are adding value, and also our own transactions are adding value. The programme is successful.”
In terms of reviewing its currency managers, Bronger explains that the process is very hands-on: “They have to send us a report every day, so we are regularly looking at how they perform.”
He believes that the Hoogovens strategy reflects the thinking of many Dutch funds with regards to currency.
“A lot of pension funds are thinking about hedging their currency exposure and I think a lot must have sold dollars in the last months.
“There is a much greater exposure to foreign equity now. At the beginning of the 1990s, Dutch pension funds were, for the large part, invested in Dutch stocks, but this has changed considerably in the last few years. “I know that there are some pension funds that hedge all their risk.”
For other European funds, the accent in currency management is firmly on risk control.
Carl Haeck, finance manager at the Brussels-based e450m VKG/CPM pension fund for Belgian doctors and dentists, says the scheme introduced a currency management strategy around four years ago, appointing State Street and Alfred Bisset & Co to separate currency briefs.
“State Street operates a more fundamental research style, while the Bisset approach is more model driven. This split in styles is used to lower the risk.”
The philosophy behind the VKG overlay programme, Haeck says, is firstly to manage the currency risk and secondly to add value where possible.
The fund monitors the performance of its managers on a monthly basis, looking at currency overlay as a distinct part of the portfolio.
He warns though that the VKG experience in currency overlay has not been a one-way bet: “Over the last two years our currency managers actually lost money. A lot of people believed that the dollar would depreciate in 2000 and 2001, but of course it kept on rising.”
As a result, the fund re-evaluated its currency position at the start of the year, but decided to stick with the policy – a decision that has paid off in the last seven months: “Our currency managers have now regained all the losses that they made previously and are now adding value,” Haeck points out.
The currency management topic, he believes, is gaining recognition in Belgium: “Quite a few pension funds in Belgium are restricted to euro assets in their allocations. But more and more I hear from our currency managers that there are increasing numbers of pension funds in Belgium that are looking at their currency exposure and seeking to manage this exposure separately.”
Vincent Lantin, senior investment officer at the e3.2bn Belgacom pension fund, explains that two years ago the fund switched from a system whereby individual equity managers would hedge their own exposure to a system of centralised currency management.
“At that time, the board here approved a new set of guidelines, which centralised the management to one manager because the previous arrangement was not efficient due to the investment overlap between some managers.”
The fund appointed one currency overlay manager, Barclays Global Investors, which would be responsible for hedging all the currency risk on a passive basis. “This means that systematically, all the non-euro exposure is 100% covered by hedging.
“We don’t try to add value, it is purely a risk management issue and we are obliged to do this by our investment guidelines.”
Lantin notes that the rise of the euro in recent months has benefited the fund, but points out that the real efficiencies were made in introducing the optimal currency management structure.
The fund monitors its manager on a monthly basis: “There is no intra—monthly rebalancing, which means that the exposure is not 100% each and every day but is rebalanced once a month.”

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