Currency overlay may see strong growth in US

Currency overlay – the management of currency exposures in an investment portfolio separate from underlying asset exposures – is set to increase in the US at a rapid rate, claimed speakers at a global foreign exchange conference hosted by Deutsche Bank on Friday. But UK pension funds are showing caution, speakers said.

The trend for active and separate management of currency exposures follows a rise in cross-border investments by institutional asset managers and pensions funds. It also provides an alternative investment given the current flagging returns from equity strategies.

In 2000, 11% of cross-border pension fund assets were overlaid, according to InterSec Research Corporation, the asset management consultancy arm of Deutsche Bank. “It’s not that 89% doesn’t know that it exists – it’s just not packaged in a form that suits their business interests,” said Ralph Smith, a currency overlay specialist at State Street Global Advisors. Now banks and specialist currency overlay managers, including Deutsche Bank, JP Morgan Fleming Asset Management, Pareto Partners and State Street Global Advisors, and are pressing hard to promote such overlay services.

Currency overlay can add value by exploiting information inefficiencies in the foreign exchange markets, said Adrian Lee, chief investment officer of UK-based investment management firm, Lee Overlay Partners. Clients are looking both to reduce currency risk and add returns through active management.

Global fixed-income managers are increasingly allocating the risk budget to currency management decisions, said Peter Eerdmans, a fixed-income research manager at international consulting and actuarial firm, Watson Wyatt. Eerdmans said the next step is to convince managers that someone else should manage the currency overlay actively.

“We expect a wave of growth next year for currency overlay in the US markets,” said Ronald Layard-Liesching, chief research officer at London-based Pareto Partners. “It is changing fast and we are very busy,” said Harriet Richmond, head of currency overlay at JP Morgan Fleming Asset Management in London. But speakers said currency overlay is still predominately an untapped tool in the UK. The UK has a large institutional market with international diversification at roughly a third of total assets, yet underlay is almost unknown, said Neil Record, chairman and chief executive of UK-based specialist overlay managers, Record Currency Management. “There is an unfamiliarity with currency at every level in the UK,” said Record, in reference to UK fund managers. “Currency as a strategy needs to be included in the initial fund management discussions,” he added.

“In the UK, this is the last thing on the agenda,” said Layard-Liesching. He said pension managers are still busy dealing with FRS 17 – a new accounting rule due for implementation in June 2003 that will force companies to fully account for pension liabilities on their corporate balance sheet.

The perception is changing, but there is a significant degree of scepticism, noted Eerdmans. ”But this is just inertia,” said Lee, “that’s what makes it so exciting.”