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State pension fund advised to steer clear of currency hedging


By Andy Metzger


BOSTON — As the dollar has grown stronger against other world currencies, the state’s pension fund is unlikely to resume a prior practice of currency hedging, which the fund quit in 2005 as the dollar slipped.

The board that manages the $61.2 billion fund heard a presentation Tuesday warning against such hedges and the fund’s executive director said it is working on an academic paper on that subject.

Andre Clapp, the fund’s senior investment officer, told the Pension Reserves Investment Management Board that hedging currency is expensive and can cause cascading problems in a down market.

Hedging can protect investors against swings in the exchange rate. Pensions & Investments, a news outlet for investors, reported that demand is growing among institutional investors for dynamic hedging strategies.

Count out the Pension Reserves Investment Trust (PRIT) fund, which finances the retirements of public employees across the state.

“As I was looking at currencies, I was trying to think is there a way that we can hedge against the fluctuation in currencies, but your analysis shows that the risks and costs far outweigh your immediate reaction … ” said Treasurer Deborah Goldberg, who chairs the pension board.

According to Clapp’s analysis, currency hedges reduce volatility in investment returns, but in the wrong direction.

Measuring the performance of a hedged index against the same index un-hedged over four decades, Clapp found that hedging moderates returns on upswings but does not diminish the effect of market crashes.

Though no vote was taken, no pension fund board members challenged Clapp on his findings and board member Michael Heffernan, Goldberg’s Republican opponent last November, suggested the findings be shared with other investors.

“We are in fact working on a white paper,” said Michael Trotsky, executive director of the pension fund and its chief investment officer. He said, “Foreign exchange hedging is such a popular thing, and we have such a differentiated view on that.”

Coming off fiscal year 2015 in which the fund posted only a 3.9 percent return, Trotsky said markets appear to be in a “peak zone,” and said there is “a lot of volatility” and a “very anemic bond market.”

Tuesday’s discussion of currency hedging followed news that the value of China’s Yuan had been devalued and that Greece had come to an agreement with its creditors.

For about a decade, from 1993 to 2005, the pension fund employed currency hedging, said Sarah Samuels, deputy chief investment officer. The practice was ended when the dollar sank in value.

Currency hedging can also require significant cash on hand, creating the undesirable potentiality that the pension fund would need to sell assets during a down market when they would be worth less, Clapp said.

“It might remove the possibility of buying and holding in bad markets and might require forced selling just at a time when you would least like to sell your assets,” Clapp told the board. From 1973, which Clapp pegged as the beginning of the modern era of currency trading, until 2014 currency hedging on a quarterly basis would cost $5.2 million per year in transaction costs alone, Clapp found.

Clapp looked at the $11.9 billion of the Bay State pension fund that is exposed to developed market currencies. He said currency hedging in emerging markets is “very expensive” because of generally higher interest rates, so he focused on currency hedging in more established markets.

The pension fund’s fiscal 2015 return of 3.9 percent is less than half the five-year return of 11 percent and also significantly below the 10-year return of 7 percent.

Trotsky noted the fund has for five years sought to reduce risk by bringing down the amount of its exposure to global equity from a 49 percent target in 2010 to a 40 percent target today. Currently 42.7 percent of the fund is tied up in global equity.

Clapp said diversification of assets is a more efficient way to reduce risk.

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