September 5, 2017

Super evolution: NAB Superannuation FX Hedging Survey 2017

Our 8th biennial survey captures the shifting priorities of Australian super funds in a rapidly changing landscape.

The Australian dollar (AUD) may have experienced abnormally low levels of volatility over the past two years, but little else stayed still. Australian superfunds made significant changes to the way they managed their currency exposures in response to an evolving environment with increased regulation, higher standards of transparency, rapid technological change and more pressure to grow or merge.

Our 8th biennial survey – the only survey of its kind to examine hedging techniques in Australia – captures their shifting priorities in this rapidly changing landscape.

In 2017, we expanded the survey to include 46 funds, with $980 billion assets under management (AUM). We also adapted and broadened our list of questions to accurately reflect the very latest trends.

Hedging strategies reach a whole new level

One of the more notable shifts in the 2017 survey’s findings relates to superfunds’ strategic approach to foreign exchange (FX) hedging.

In 2001, 91% of respondents were hedging at an asset class level. Today, funds are showing a distinct preference for hedging at a whole-of-fund level (48%) while a significant proportion (15%) are now favouring a member investment choice (MIC) level.

Despite this, hedging itself is still done at the asset class level for the most part.

Taking a dynamic approach to international equities

It’s also clear that dynamic hedging is becoming increasingly important in international equities (IE) as more funds move away from a set hedge ratio.

In 2017, 43% of funds indicated they were hedging IE dynamically, a considerable jump from 17% in 2015.

At the same time, there was a distinct rise in the percentage of funds who said they were using a ‘tilting’ strategy for their hedge ratio around a strategic hedge ratio – 74% compared to 54% in 2015.

In fact many funds use the terms dynamic and tilting interchangeably when it comes to their hedge ratio and there is some discrepancy between those who use tilting to mean a small move around the strategic hedge ratio and those who use it to mean a significant move around a central hedge ratio. Understandably, the end result is a bifurcation in the survey findings.

The target hedge ratios in IE that were reported turned out to be lower than in 2015 (39% compared to 53%). This fits in with the general view that the AUD is likely to move lower with time.

What to do with emerging markets FX exposure?

Another theme to dominate the 2017 survey was emerging markets (EM). The findings show that while there has been a marked increase in EM investment, there has been very little hedging – 79% of funds chose not to hedge their equity exposure and over half (52%) opted not to hedge their fixed income exposure.

Why the reticence? It may be something to do with the dramatic sell-off of EM currencies in 2015 and early 2016, resulting in a plunge in prices. It usually makes less sense to hedge in such circumstances.

At the same time, there is no sign that the new collateral and variation margin regulations are having an impact on EM FX hedging – or on hedging in general for that matter.

The inevitable pull of regulatory change

Yet the changing regulatory environment is definitely impacting other areas. Transaction cost analysis (TCA) and reporting of ASIC Regulatory Guide 97 (RG 97) is now front of mind for the vast majority of funds. A significant 73% of respondents said they were implementing – or were considering implementing – a TCA framework around FX hedging.

Choosing the right framework is by no means easy, however, and almost three quarters of those interviewed (76%) indicated they were looking for a bank/manager to provide a TCA service. Only 9% were intending to build something themselves.

Meanwhile, more than half the survey respondents (54%) said they were considering the domicile of the counterparty in FX forwards now changes to the regulations mean it can influence the tax paid on any gains.

The ins and outs of who does the hedging

While external currency overlay managers continue to do most of the hedging (74%), and 80% of funds are intent on keeping it that way, there are signs of change here too as regulations take their toll and superfunds merge and expand.

According to the survey findings, there has been a distinct rise in those looking to insource their hedging (up from 5% in 2015 to 11% in 2017) while the percentage considering outsourcing has also increased (from 5% in 2015 to 9% in 2017).

The former finding may reflect those newly merged superfunds that are now big enough to consider taking on their own currency hedging. Those considering outsourcing, meanwhile, may be smaller funds that are reaching a size where external help is warranted.

Product of choice: sticking to a good thing

With the decline in AUD volatility and a focus on dynamic hedging strategies it may not be surprising that funds prefer passive – rather than active – management, while all hedges are being used as a risk-management tool. Certainly the current environment is not conducive to generating currency alpha.

Meanwhile, the love affair with FX forwards continues with 100% of the survey’s respondents preferring them to any other hedging tools. It still makes a lot of sense. After all, they are simple, liquid and avoid the raft of regulatory factors just now.

For deeper insights into the current evolution of FX hedging, Regulation and market conditions on the Super Funds’ investment environment, request a copy of the full survey.

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