Pimco Quants Say Too Many Investors Are Getting Hedges Wrongby and
Important to take ‘currency-by-currency’ approach: Pimco says
Aussie moves in line with riskier assets, yen moves inversely
Pacific Investment Management Co. says one-size-fits-all hedging tactics are undermining pension returns.
Many institutional investors choose uniform currency protection for each asset class, and that means they miss out on the opportunity to benefit from the way some exchange rates are correlated with moves in riskier assets, says Pimco, which oversees $1.5 trillion of assets. So Australian-based investors fail to reap the full benefits from their dollar’s tendency to strengthen when stock markets rise and their Japanese counterparts aren’t getting the most from the yen’s habit of climbing when equities fall.
The standard practice among Australian multi-asset managers, which invest on behalf of the world’s fifth-largest pension pool, is to hedge around one third of their foreign-exchange exposure for global equities. The need to protect income has never been more acute as unprecedented monetary easing from Japan to Europe sends global yields to record lows, and retirees reliant on steady income streams are being forced to live on less amid compressed returns.
“Our research shows that this sort of strategy can significantly reduce the risks for multi-asset portfolios,” Laura Ryan, a Sydney-based quantitative research analyst at Pimco, said in an interview last week. “At a time when many of our clients are investing to manage their savings after retirement, mitigating downside risks is vital.”
Investors across Australia’s A$2.1 trillion ($1.6 trillion) pension savings sector are better off hedging against fluctuations in the dollar, Canadian loonie and the pound, given the Aussie is already high-risk, while applying 100 percent protection for bonds, according to Ryan.
The yen draws interest in times of stress, while the Australian dollar tends to correlate positively with equities and gains when markets are on the rise, Ryan and Helen Guo, a quantitative research analyst based at Pimco’s head office in Newport Beach, California, wrote in a paper on currency hedging optimization.
An Aussie investor that hedged its currency exposure to the S&P 500 Index would have made a gain of 5.7 percent this year through Monday’s close, while the return if remaining unhedged would be 0.5 percent. And an Australian buying the Nikkei 225 Stock Average would have limited losses to 1.8 percent as of Tuesday by avoiding any currency protection, while a hedged investor would be out of pocket to the tune of 12 percent.
“For an Australian investor who starts with zero hedging on a multi-asset portfolio, protecting against moves in the U.S. and Canadian dollars and the pound would curb risks, while hedging against moves in the euro, the yen and the franc would increase risks,” Ryan said. “This highlights the importance of taking a currency-by-currency approach to the FX hedging decision.”
Pimco has already implemented its currency-by-currency hedging strategy for a “few clients” and so far the outcome has been “positive,” Ryan said. She declined to name them.
The analysts assumptions used the Aussie, yen and the dollar as base currencies, with a portfolio comprising 60 percent equities and 40 percent bonds, split equally between domestic and global assets, they said. Pimco considered seven currencies for hedging -- dollar, euro, yen, pound, Canada’s loonie, Aussie and Swiss franc.