In May, The Royal Borough of Windsor and Maidenhead tendered a E599m currency overlay mandate for the £1.3bn (E1.9bn) Berkshire Pension Fund. It is one of a string of pension funds who are looking at diversifying risk through currency overlay. Other recent funds include Strathclyde, which hired Mellon Capital Management, Millennium, and Record Currency Management for overlay mandates, as well as the Leicestershire County Council Pension Fund, Cornwall, and the Lothian Pension Fund. And others, like Denmark’s PKA, are also considering moving into currency overlay. PKA says it needs to analyse the issue further, before making a commitment.
Investing in currencies is in the sense of a trading strategy, say managers, where you try to extract value over time. It is akin to what hedge funds do in other markets, although currency managers do not like to be compared to hedge funds. Overlays can add alpha, but also value through the diversification of risk.
Still, some managers separate currency overlay from tactical asset allocation (TAA). Daan Potjer, senior vice president and head of tactical asset allocation/balanced mandates portfolio management at ABN Amro Asset Management, says the firm has a separate currency team and separate TAA team so that it can benefit from the uncorrelated returns of currency. “The returns coming from the currency side and TAA are uncorrelated and the information ratio on our fund would be higher than if we had one integrated approach. We don’t want to depend just on currencies, we want the contribution from TAA and currencies to be roughly equal.” The firm has E21bn in TAA and a further E20bn in currencies. Like many firms, it is offering global tactical asset allocation products, which often uses a derivative contract as a cheaper way to get exposure to a market.
“It doesn’t mean that the risk is inherently greater. They may be taking exposure to derivatives, but potentially reducing risk through diversification,” explains Thomas Aubrey, director of investment management at Thomson Financial.
Still, managers have a long way to go before they convert all pension funds. “We have had some reservations about TAA in the past, but in these markets, and with the new products on the market, it’s basically a question of going through and seeing if things have changed,” says PKA’s Joergensen. One of the firm’s reservations was whether people were really making money through the strategy.
For his part, Aubrey believes it is a waiting game. “GTAA funds are true active management funds, with the fund companies arguing that they can beat the market. Until there is enough data showing that these funds are here to stay and can add value, there won’t be a lot of mandates.”
GTAA funds typically offer an information ratio of half – so that if a fund has 20% volatility, it can expect a performance of 10%.
Participants point out that getting your asset allocation right is half the battle. And for pension funds who want to make sure that all their cash is invested, while keeping in line with their benchmark, there is exposure management, explains Alistair Lowe, head of global asset allocation and currency at SSgA. “If you have cash sitting around because you have contributions coming in, money pending benefit payments, or money that your private equity manager hasn’t called yet, you may not want to fund everything and then the markets move and you’re out of line. You can hire someone to passively use derivatives to make sure all the cash is invested,” he explains, pointing out that while cash may yield 5%, with equities you have a long-term expectation of 8%. “If you have an exposure manager, you don’t need to re-balance your physical managers that often.”
Lowe says that exposure management is “a bit more expensive than indexing, and a lot less than active management,” a few basis points, rather than dozens of basis points. SSgA is currently running an exposure mandate for France’s FRR, but says that the approach is just starting to pick up in Europe. He also believes that pension funds are becoming more comfortable with derivatives. “People are realising that derivatives aren’t necessarily bad, although you can use them badly. You just need to make sure you have a manager with a strong risk control culture, with operational checks and balances,” he says.

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