NAB superannuation FX Survey illuminates currency trends

With the NAB Superannuation FX Survey complete, the findings will make important reading for many superannuation fund trustees seeking to understand the implications of recent currency movements. 

The 2013 NAB Superannuation FX Survey reveals that currency still matters.

In fact, superfunds recognise it is becoming increasingly important. Some 83 per cent of superfunds ranked currency as an important issue for the fund. This is significantly higher than the 73 per cent reported in 2011.  

Historical data highlights the importance of making the right hedging at the right time. 

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”Over the past five years, by doing nothing more than passively hedging all the currency exposure associated with investing in the MSCI World (excluding Australia) Index, superfunds would have added an average of 3.5 per cent per annum to the returns on foreign assets,” comments Danica Hampton, Director, Currency Overlay, NAB. 

“On the flipside, if currency exposures were left unhedged, currency would have subtracted 1.6 per cent per year from the returns on their international equity portfolio.”  

The currency contribution difference over the past five years between a fully hedged and unhedged MSCI World (excluding Australia) equity portfolio roughly equates to 5.0 per cent  per annum(+3.3 per cent - -1.6 per cent). 

“If, on average, Australian superfunds are 18.2 per cent exposed to currency, then cumulatively superfunds have forgone an additional 0.9 per cent of return per annum over the past five years,” notes Hampton.

That said, looking at the year ending June 2013 yields a completely different story. The decline in the currency over this period meant the currency contributed 8.8 per cent to an unhedged portfolio, materially more than a fully hedged portfolio that benefited just 1.2 per cent. 

“A decision to be fully hedged over the past financial year would have reduced international equity portfolio returns by roughly 7.6 per cent (+1.2 per cent - +8.8 per cent),” comments Hampton. 

“What you decide to do with currency could make the difference between whether you sit in the upper or lower quartile of the leader board in any given year.”  

Currency complexity 

Superfunds openly acknowledge that forecasting the currency is difficult – even for the experts. While 16 per cent of superfunds think currency specialists are best able to predict currencies over the 12-month horizon, the overwhelming majority – 80 per cent – think nobody is able to predict the currency.

However, superfunds have some strong opinions about the broad direction of the AUD, with 67 per cent believing it will continue a downwards trajectory over the next two years, while only 9 per cent think an upswing is on the way. 

In general, superfunds also agree there’s been a paradigm shift in the AUD. Some 77 per cent of superfunds think the AUS/USD is in a new higher range, which is slightly down from the 88 per cent in 2011.

While forecasting the currency is fraught with difficulty, there is some agreement on what factors will influence it. Around 45 per cent of superfunds think economic competitiveness and policies to spur on growth, including quantitative easing, will be the primary influence on the currency over the next two years.   

“Superfunds are acutely aware that international policy-makers’ tinkering with levers to stimulate growth can have a profound impact on both the direction and volatility of currency markets,” says Hampton.

Currency risk 

How are superfunds managing currency risk? 

Overall, superfund exposure to foreign currency has risen to 18.2 per cent, up from the 17.0 per cent seen in 2011.  

Hedge ratios across most asset classes have fallen. International equities dropped to 32 per cent from 40 per cent, while international property plummeted from 87 per cent in 2011 to 68 per cent.  

Some 50 per cent of superfunds now make currency decisions at the total fund level, rather than by asset class (up from 41 per cent in 2011). 

One of the most critical revelations of the 2013 Survey is the clear trend towards establishing a currency strategy for the total fund rather than on individual asset classes. 

Historically, most superfunds made currency decisions on an asset class basis. It was common to see high hedge benchmarks for international fixed income assets, and a near 50 per cent hedge benchmark for international equities. 

Fifty per cent of funds have walked away from managing currency on an asset class basis and are now managing currency at the total fund level. This is a solid increase on the 41 per cent seen in 2011, and the 22 per cent who did so in 2009.  

“Increasingly managers are trying to figure out what level of FX exposure generates the best risk-adjusted return for their particular fund,” says Hampton.

“This is has driven superfunds away from asset class thinking and towards the total portfolio approach. The conviction of this trend is compelling evidence that superfunds have developed a deeper understanding about the impact of currency.” 

Over the last two years, hedge ratios across most asset classes have fallen – some dramatically. International equities have dropped to 32 per cent from 40 per cent in 2011.

The average hedge ratio on international equities is now at the lowest level in the history of the survey.   

The hedge ratio on international fixed income assets remains high. Across all types of funds, it did ease slightly to 91 per cent from 94 per cent in 2011.  

The 2013 results showed a mixed approach to illiquid assets. There was a significant fall in the benchmark hedge level for international property from 87 per cent in 2011 to 68 per cent. 

Similarly, the hedge ratio for international infrastructure has also been materially reduced from 77 per cent to 71 per cent, reflecting a more proactive approach to understanding the dynamics and considerations of hedging each asset class, while taking an overall fund approach to currency exposure. 

The changes to hedge ratios on other asset classes were less profound. Private equity remains a 50:50 call; 70 per cent of respondents are invested in private equity and the hedge ratio has increased to 58 per cent in 2013 from 52 per cent in 2011.