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Benefits and Pensions MonitorCurrency Erodes Returns From U.S.By: Joe Hornyak With Canadian pension plans looking for an eight per cent return, annualized for the next 20 years, investing in the U.S. may not be the most attractive option, right now.
”Mind you,” says Janet Rabovsky, of Watson Wyatt, “they’ve been looking at that for a long time.” Over the last five years, U.S. assets returned -4.4 per cent for Canadian pension funds. “A lot of that was actually due to the currency and we probably would say the U.S. is one of the least attractive regions around the world.” In fact, she says plan sponsors are typically looking at having global allocations rather than looking at U.S. and EAFE. “Traditionally, that’s worked out ‘okay’ because the benchmark, the MSCI World, was roughly a little more than 50 per cent for the U.S. and a little under 50 for EAFE. As well, she is seeing a number of sponsors go passive U.S. or index enhanced. It’s “more of a structured approach, the idea being that you’re getting a little bit of return from each decision that you make,” she says. Since the U.S. is one of the most efficient markets, “our view is, if you’re going to be active, index enhanced is probably the most efficient way.” Big Enough The issue with the U.S. market is you need to be big enough to go growth and value and have some pretty concentrated portfolios in order to get enough return from active management to support the fees. “If you’re just allocating to a core manager, you really eroding the majority of your return with your excess management fees.” On the other hand, when thinking about risk-based strategies, “if you’re allocating to your asset classes based on risk, you’re really not going to get a good enough return to put a lot of your risk budget into the U.S.” That means fund managers could do something like alpha transfer strategies over long bonds or hedge funds. “That’s certainly one way to access the U.S. long/short market neutral. There are ways to actually wring some alpha out, but these are more sophisticated and you need a governance group which is able to actually understand the strategies and a custodian who can monitor them.” Rabovsky isn’t sure whether or not the U.S. currency has bottomed out. “If you listen to what the economists are saying, they still think that there is a prospect for appreciation, anywhere between 85 and 90 is actually a reasonable expectation over the next year.” And while it was, at one point, the Canadian dollar’s strength that was driving it forward, now it’s the U.S. dollar’s weakness. Canadian Perspective From a Canadian perspective, Rabovsky says there are a few things to consider. The Canadian dollar has been moving, in fact, more strongly against the euro and the pound. Given this, for pension funds that are invested outside of Canada, “the time has come to basically have some sort of currency policy.” This policy could be to have “an explicit discussion that says ‘I’m OK with the variability of return’.” It doesn’t necessarily mean hedging, she says, “but it could mean hedging.” Wherever the U.S. dollar goes, it does mean sponsors need “a coherent approach to foreign assets. It is having those discussions about currency hedging and understanding the plan’s or the governing group’s tolerance for risk and variability of return because, really, that’s what’s important.” So the real issue is not only where sponsors are going to invest, but how they’re going to manage the currency. Jonathan Passmore, senior vice-president and portfolio manager, international equities, at GE, says currency issues are a very important part of the equation for portfolio managers investing in international markets, GE, for example, as a bottom-up investor, incorporates its views on currency at the individual stock level. “When we analyze the issues affecting a currency, we prefer to take a medium to long-term view. Right now, for example, commodity and resource-backed currencies such as the Canadian dollar are doing well against the consumer currencies and, barring a collapse in commodity prices, should continue to do so,” says Passmore. Undue Importance For Canadian investors, the loonie’s performance against the U.S. has eroded returns from U.S. sources, a key factor when considering investing in the U.S. However, Canadian investors must be aware of the undue importance that Canadians attach to the Canadian dollar/U.S. dollar relationship which “is probably due, in large part, to their proximity and the significance of U.S. investments held in Canadian portfolios today.” Hedging is another issue. GE avoids hedging because “hedging is expensive, and that expense is something Canadian investors need to keep in mind as they look at investments in U.S. and other international assets.” However, he says “hedging is intriguing, partly because it is a double-edged sword. It can insure you against risks, but, by virtue of its cost, reduces your upside potential.” Joe Hornyak is executive editor of Benefits and Pensions Monitor. |
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