Currency Risk – Take It Or Leave It

Online debate explores active versus passive approaches.

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story_images_dollars-funnelWith the loonie floating close to parity with the greenback, currency hedging is top of mind for plan sponsors with substantial international exposures. And for good reason. A rising loonie can negate gains on international securities portfolios.

Neutralizing currency effects has an appeal. But how to do it? “In absence of clear guidance from the statistics, we might simply ask what hedging decision is least likely to cause regret and elect a 50% hedge on foreign assets,” suggests Michael Lewis, a principal at Mercer. Lewis is the moderator for Canadian Investment Review’s online currency hedging debate, which started on July 20th.

Active currency management is an option because “it can generate positive returns irrespective of whether the Canadian dollar weakens or strengthens,” says Thanos Papasavvas, head of currency management at Investec Asset Management. “Currencies may be the most liquid asset class but it still remains inherently inefficient due to the involvement of central banks, corporate treasurers and other market participants who transact in foreign exchange for reasons other than profit.”

But active management can be expensive, argues Jay Moore, managing director at State Street Associates. Instead, he says, “As with all markets, forecasting the direction of currency valuation is difficult. Although this makes active hedging difficult, the unrivaled liquidity of the currency market presents an opportunity for investors to dynamically adjust hedge ratios quickly and cheaply through time.”

Before making a decision about active or passive hedges, a pension plan’s asset allocation policy has to be appropriately benchmarked, says guest analyst August Cruikshanks, Canadian head of research and co-head of global equities at Hewitt Associates. “For example, we would need to look carefully at the attribution analysis of an active EAFE manager who is consistently underweight Japan and be aware of how an unhedged performance record can be potentially distorted by currency effects.”

Add to that the fact that an investor seeking to hedge a specific currency may be confounded by equities whose revenues are predominantly derived from abroad. That’s one kink. There are others that confound the case for currency hedging.

“The trouble for pension trustees seems to be that, when looking at historical data, one can find periods when hedging helps, hurts or does very little. An investor looking for the hard evidence to hedge has trouble finding it,” notes guest analyst Perry Teperson, vice-president and portfolio manager at Leith Wheeler Investment Counsel.

Do you want to read more from the debate participants and follow the currency hedging online discussion? Visit If you are a plan sponsor and do not yet have a username and password, contact CIR Online Debates editor, Laurie Asuncion.

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