With professional trustees predicting increased exposure to currency, schemes have been called to pursue transparency and audit data in their trades to protect their investments
If they do not manage large currency trades properly, the ramifications could be costly for schemes, the National Association of Pension Funds (NAPF) warned in a guide released last month.
Schemes could lose money either in currency fluctuations meaning overseas assets are worth less when converted back into sterling; or when they are making a specific returns-driven allocation, the money market can move against them as with any other investment.
Those interested in foreign exchange (FX) – either as a hedge or a returns-driven investment – need to identify their risk exposure and train their trustee boards in this complex investment, according to independent trustees.
A transparent and risk-monitored currency allocation could bring money into the scheme, increasing its funding level and so providing greater security to the retirement income of its members.
In its guide, the NAPF has set out the risks in executing currency investment and guidance on how to deal with their FX fund managers.
It said schemes should require full disclosure of execution costs and transparency in setting traded prices from their manager.
They should also determine if trades will be handled on a principal or agency basis, and request explanation of these options.
The report recommended three safeguards for efficient currency investment:
The manager should have a clear execution process to flag potential risks;
The price at which the currency is traded should be set explicitly between the scheme’s agent and the scheme’s counterparty;
The data for an audit trial should be available, and such audits should be performed regularly.
Steve Delo, chief executive of Pan Governance, said schemes need to have a clear understanding of their risk exposure and what their manager is doing.
He said: “I’m aware of many trustee boards which have got their fingers burned here because they haven’t understood the risks they’ve exposed themselves to.”
Schemes looking to invest in currency need to bring in the services of an independent third party to give the trustee board some “intensive training” on FX, he said.
He added: “Identify what the risks and dynamics are, and put the monitoring protocols in place. Used wisely, it’s something that can add value, but it needs to be used wisely.”
There are two predominant ways schemes use currency.
A passive hedge for their currency exposure of their overseas investments;
Hiring a manager to play the currency markets to generate excess revenue.
“More and more schemes are taking a proper look at the management of risk within their fund,” said Anne Kershaw, associate director at Muse Advisory.
“Currency hedging is another area where risk is often taken off the table.”
Richard Butcher, managing director of Pitmans Trustees, said the company had no set guidelines for using FX funds, and would only use them on receipt of formal advice from a client scheme’s investment adviser.
He said: “This is the only guideline for two reasons: because our clients have a very low exposure to them and because each client and each scheme sponsor has a different attitude to risk.”
But he added he could see increased exposure to FX from UK schemes in the future, due to the increasing correlation between the UK and some overseas markets.
He added: “This means that we can get increased diversification within our portfolios for modest additional risk, the key residual risk being currency movement.
“We would use FX funds, subject to advice and the sponsor’s view, to hedge this.”
