FX increasingly a 'source of alpha', rather than simply a hedging tool

GLOBAL - Currency investments are increasingly being viewed as a source of alpha, rather than a tool for hedging investment risk, according to Adrian Lee & Partners.

The company said schemes should seek to balance their portfolios by considering investment in both emerging market and developed country FX.

Pension funds have changed their approach to currencies in recent decades and are now adopting an active management strategy, the company’s founder and chief executive Adrian Lee said.

He said pension funds had long been engaged in the FX market due to their exposure to foreign equities and bonds.

“While they traditionally used currencies as a hedging tool to protect their portfolio against some potential risk arising, they are now seeing currencies as a separate asset class,” he said.

He said pension funds should target only the better-performing currencies with a high yield and low inflation attached to them to add value to their portfolio.

However, Lee also argued that investing solely in emerging market currencies would be a mistake.

Even though emerging market currencies currently show strong growth potential and are still slightly undervalued - representing all the good characteristics for investors - pension funds should balance their portfolios with currencies from developed nations, he said.

“Because investors want to retain the best-performing currencies in their portfolio, they also need to invest in developed currencies to have instruments to sell in the future,” he added.

“The key for pension funds now is to look at currencies that are reasonably liquidly traded and reasonably fundamentally driven.”

It is a viewpoint shared by pension funds. In an earlier interview with IPE, Michaela Attermeyer, head of investments at the Austrian pension fund VBV Pensionskasse, said: “Emerging market currencies have more appreciation potential than currencies in developed markets, particularly compared with the euro or the US dollar.

“The credit ratings of companies in emerging markets are often just as sound, or even better than that of companies in developed countries, and they still manage to generate a higher return at the same time.”