Aussie Finds Friend as $1.4 Trillion Pension Pool Buys on Lossesby
Local fund managers cut foreign-exchange exposure, buy Aussie
Currency hedges for equities are highest since at least 2013
Australia’s $1.4 trillion local pension fund industry is one of the few friends the nation’s currency has left during its worst start to a year.
Superannuation fund managers have been buying the Aussie to trim foreign-exchange exposure and increasing how much they hedge their offshore investments. After the local dollar’s more than 30 percent slide since early 2013 boosted returns on their international equity and bond holdings, investors are becoming more cautious about remaining too exposed to swings in the currency market, Macquarie Bank Ltd. said.
“In conversations with super funds, it’s pretty clear that many of them still have to nudge their FX hedge ratios higher in order to get back to historical, normal benchmark levels,” said Gareth Berry, a foreign-exchange and rates strategist at Macquarie in Singapore. “They will buy Aussie opportunistically on dips and that is a source of some comfort for the currency and will provide a degree of buoyancy. It won’t change the trend, but it will moderate the magnitude of any downswing.”
Australia’s dollar has been the worst-hit among developed-market peers over the start of this year amid panic in trading partner China’s financial markets and weakening commodity prices. Strategists see declines slowing in 2016, with the median forecast indicating a 3.9 percent annual loss compared with a drop of at least 8 percent in each of the past three years.
Pension funds had already started to adapt to this outlook. About 29 percent of the A$289.8 billion ($201.9 billion) invested in listed international equities was hedged against currency moves in the third quarter, up from 20 percent in the same period of 2013, according to industry data. For fixed income, the ratio climbed to 64 percent from 57.
At least 20 percent of the world’s fourth-largest pool of savings was invested in international markets at the end of September, according to data compiled by the Australian Prudential Regulation Authority. Allocations to offshore bonds and equities climbed more than 50 percent over two years.
While managers increased how exposed these assets were to movements in the Aussie when it traded above parity with the greenback, expecting a boost to returns as the currency dropped, they are now making large purchases of the local dollar to increase hedge ratios, Macquarie’s Berry said.
The Aussie’s decline “is not fully done yet, but it’s mostly behind us and I think that’s a very sensible investment strategy,” he said, predicting a drop to 66 U.S. cents this year.
Australia’s dollar bought 69.77 cents as of 4 p.m. in Sydney on Monday, down 4.4 percent since Dec. 31. It is still holding above an almost seven-year low of 68.96 reached in September, with analysts predicting it will end the year at 70 cents.
Nader Naeimi, head of dynamic markets at AMP Capital Investors, says he actively hedges currency exposure because the Aussie has been a valuable lever to change the overall risk associated with his fund holdings. Bets that the currency will drop against the yen and euro have helped cushion returns in the recent equity selloff, according to Naeimi, who helps manage about $110 billion at AMP.
“If the Aussie dollar falls any more, we will start increasing our hedge ratio and increasing our Aussie dollar exposure,” Sydney-based Naeimi said. “From here on, it’s more of a range trade, so if the Aussie falls into the high-to-mid 60s, we will increase our FX hedges, and if it climbs to the 73-75 region, then we’ll reduce our hedge.”
The currency averaged $1.03 in 2011, a time at which about 17 percent of super funds’ international investments were left exposed to foreign-exchange fluctuations, a National Australia Bank Ltd. survey released in November showed. The currency’s subsequent decline spurred managers to take that exposure to 24 percent on average last year, with the level rising to 53 percent for international equities, according to the survey which covered 40 funds with about A$682 billion under management.
The impact of hedging on fund performance has been significant. The Standard & Poor’s 500 Index has returned 30 percent, including reinvested dividends, on an annualized basis in Aussie-dollar terms over the three years to December 2015, compared with 15 percent in U.S. dollars.
“Some of them will adjust their hedge ratios the further the Aussie dollar falls,” said Emma Lawson, a director of currency at NAB. “As you go from 75 to 70 and the potential downside is less, then funds are looking at that decision, but I wouldn’t say as a whole that it’s being implemented yet and many of them have different thresholds.”