National Australia Bank (NAB) has launched its biennial 2019 Superannuation FX hedging survey, the ninth such survey that seeks to provide detailed analysis of how Australian super funds manage their currency exposures. Australia has the fourth biggest superannuation pool in the world, as at December 2018 assets stood at AUD 2.7 trillion, of which around AUD 1.8 trillion is institutional money, with the balance being in private self-managed funds.
“This is the only survey of its kind in Australia thanks to the level of detail it goes into around how asset owners are managing their currency risk,” says Jamie Bonic, head of FX investor sales at NAB in Sydney. “Our aim this year is to survey as many as 60 funds with assets under management (AUM) of approximately AUD 1.2-1.3 trillion, which will make it our deepest survey set to date.”
In terms of areas covered by the survey, it examines in detail who has the most influence in setting the strategic hedge policy, how often currency hedging decisions are reviewed and how hedging is implemented within the Fund. It also looks at the increasing importance of transparency on all aspects of currency management and transactional cost analysis.
“Superfunds are always interested in understanding what their peers are doing, and FX is the least reported and understood exposure in a diversified portfolio,” says Bonic. “This survey is acknowledged as a great way to keep track of changes in currency exposures across the industry.”
The sheer size of the Australian pension industry means it inevitably attracts offshore attention, as Bonic observes, “All the major investors either have a permanent presence here or are on the ground regularly – and this will only increase”, and according to ASFA (the Association of Super Funds Australia) the growth in assets is likely to see AUM hit AUD 3 trillion in 2021 and AUD 4 trillion in 2025.
Along with this growth has come an increased focus on geographical diversification. Mike Symonds, director of currency overlay solutions at NAB observes that the ratio of international equities has risen over the past five years and is now at 24% according to ASFA and adds, “As AUM grows inevitably there will be a higher bias to international equities.
“It is not just in equities that we are seeing this diversification either,” he continues. “Managers are increasingly interested in unlisted longer-dated assets like infrastructure, and there is only so much infrastructure investment available in Australia. As they invest more offshore their currency exposures will grow. We are talking to a lot of funds who are increasingly recognising currency as their biggest risk beyond equity risk in their portfolios.”
Points of Interest
A potentially interesting outcome of the survey will be high-level attitudes to currency hedging, especially with FX volatility at or near historic lows. Symonds observes that while it is generally accepted that the Australian dollar is most comfortable between 0.70 and 0.80 cents to the US dollar, it has actually spent 54% of the time post-float in 1983, outside of this range. Inspite of this, the relative stability of the AUD has led, in some quarters, to managers adopting “minimum regret” hedging strategies where they have a 50% hedge ratio. “Over a longer term cycle, however, currency can have a significant impact, both positive and negative,” Symonds says. “For instance looking at the MSCI World Index, in 2017 investors fully hedged outperformed by 3.7% yet over five years unhedged investors outperformed by 1.6%.
“The nature of currency returns for Australian investors over the long term highlights that a ‘set and forget’ strategy is not optimal in the longer term. Currency risk cannot be ignored,” he adds.
Bonic believes that many superannuation funds should be looking to elevate currency conversations at their investment committee. “Funds recognise it is a very important risk but the conversations are not generally front of mind as far as investment committees are concerned – perhaps it should be more often,” he suggests.
In terms of other outcomes expected to attract interest, Symonds suggests there are several key areas. “Some of the key metrics we will be looking out for are how frequently are funds reviewing currency issues compared to previous surveys?” he says. “We will also look at how the average hedge ratio for international equities has changed since 2017. The hedge ratio for International equities has historically been the swing factor for Funds across their International assets.
“Tilting around a target hedge ratio has also become more popular. In 2015 53% of respondents said they tilt, and this rose to 74% in 2017 – will we see that trend continue?” he adds. “What factors have driven any changes in the hedge ratio? Are funds using cross currency swaps or options as part of their hedging tools? We have found in the past that typically they use rolling forwards out to three months.”
Another potentially interesting finding will be how managers hedge emerging market risk. Symonds says that a slightly surprising finding in 2017 was the high use of proxies for EM exposures. “The last survey found an increased exposure to EM but lower hedging ratios,” he explains. “It will be interesting to see if that has changed in this latest survey and if funds are using more NDFs for example. In 2017 only 18% of funds used NDFs.”
The survey may also deliver a snapshot of managers’ willingness or ability to implement change, especially around the workflow aspects of their business. “In 2017 73% of respondents said they were considering or implementing TCA tools,” Symonds says. “Have these funds actually taken action since then? Do these funds believe there are efficiencies that can still be captured across the trade lifecycle, for example through the greater use of algos?”
As an example of the granularity delivered by the survey, Bonic also points to the tax implications for Super Funds from their hedging programmes. “Superfunds have had to look closely at the source of foreign currency hedging gains for the purpose of their tax obligations and this has potential implications on how they implement their hedging”
The survey will also look further into the impact of regulation such as Funds’ attitudes towards the FX Global Code, something that Bonic believes could be illuminating. “At some stage the regulators are going to look at the Superfunds and ask why they haven’t signed up to the Global Code,” he says. “The Code is about good governance and being a good market citizen and is for all market participants, so it will be interesting to see how Superfunds plan to respond.”
Taking the Pulse and Delivering Solutions
The survey is taken during the month of April and interviews with managers are conducted independently by Ronan Walsh from Marose Consulting, with NAB designing and hosting the survey. The results are released at a conference hosted by NAB in August in Melbourne.
As part of the wider work with the Superannuation sector, and returning to the overarching theme of currency hedging, if Superfunds decide they do need to alter their hedging policy and become a little more tactical in how they hedge, the bank provides what NAB’s head of FX strategy Ray Attrill describes as a “currency decision framework” to help them become more dynamic in their hedging.
“We don’t think managers should just stay at 50% hedge ratio,” Attrill says. “They should be thinking more tactically and this framework can underpin their discussions at investment committee level. The basic premise is the framework alerts when the currency is a certain percentage away from fair value, above and below, and that could allow the hedging ratio to be dynamically altered to take advantage of short-term variations.”
As an example, Attrill says NAB spoke to a lot of Superfunds during and immediately after the January flash event in AUD and while some had the ability to take advantage of the sharp fall in the Australian dollars, others didn’t. “Everyone we spoke to was interested but of course by the time they could have decided something it was too late,” accepts Attrill. “However, our model can help build efficiency into that hedging decision making process and make it easier to exploit short-term moves.
“This is not moving from passive to active hedging,” he stresses. “Rather it is about providing the framework to tactically take advantage of market levels.”
With the survey covering all four main sectors of Australian superannuation funds – Industry, Government, Retail and Corporate – Bonic is confident that it will deliver insightful results. He also believes that the survey is widely seen as the most value-add piece of research NAB delivers. “Managers continue to hunt for yield and diversification, especially offshore,” he says. “This raises the importance of their currency hedging regimes even further. By conducting and delivering this survey we believe we can help Superfunds better understand what their hedging programmes should look like.
“This is not about selling products,” he reiterates. “We see this survey as providing thought leadership and a demonstration of our commitment to working with this sector of our industry.”