What Are You Hedging?
Asset owners need many hands to count the number of risks their portfolios face right now. But which of them can be hedged—and which should be?
Conflicting commentaries from asset managers, consultants, columnists, banks, and regulators have told us in recent weeks that: Greece is about to exit the Eurozone—and that it will definitely stay; China is the biggest worry out there right now—and it’s just a bit of equity market volatility; and the Federal Reserve will raise its base interest rate for the first time since June 2006—okay, we’re all pretty sure that will happen in September.
Instead of adding to the billions of megabytes of speculation about what really is the biggest risk, CIO asked three top asset owners (two Power 100 members and a Forty Under Forty alum) what they were hedging, how, and why.
Interest rates: Anders Hjælmsø Svennesen, CIO, Danica (Denmark)
Art by Chris BuzelliSince joining the €41 billion ($45 billion) Danica pension
fund in December 2014, Anders Svennesen has wasted no time in making his mark
on the portfolio. The former ATP co-CIO was tasked with building a strategy
“from scratch”, and is making full use of the academic approach he learned at
his previous employer.
Danica’s team is hedging against both falling and rising nominal interest rates, Svennesen tells CIO.
With the major central banks in developed markets all currently holding their base rates at marginally above zero, hedging against further falls seems unnecessary at first. But in Denmark, they know better: the Nationalbank took its rate into negative territory in mid-2012, and—after a brief adventure above zero last summer—slashed it four times at the start of 2015 to its current level of 0.75%.
“We need to hedge our guaranteed pensions in order to make sure that we can give our customers the future pensions that we have promised them,” Svennesen says. “Furthermore, interest rates are very volatile and at current levels they can make a larger move in either direction.”
The Danish central bank has made clear its intention to peg its currency, the krone, to the euro as closely as possible. Ongoing discussions over Greece’s woes could yet be felt 1,700 miles to the north-west. While this is still the case, Svennesen and Danica will continue to use swaptions to mitigate interest rate volatility.
The Other Hedgers
Currency risk—Stefan Beiner, PUBLICA
Everything—Ian McKinlay, Aviva
Currency risk: Stefan Beiner, CIO, PUBLICA (Switzerland)
Art by Edward KinsellaCentral banks can be challenging for
investors—just ask the Swiss.
On January 15 this year, the Swiss National Bank announced, somewhat unexpectedly, that it would no longer peg the Swiss franc to the euro. In contrast to Denmark, the Swiss wanted to distance themselves from the Eurozone’s continuing problems.
Chaos ensued in the next few hours. Swiss stocks plunged in value, the franc soared relative to both the euro and the dollar, and some currency traders began to look very worried indeed.
In Bern, Switzerland, however, Stefan Beiner was less concerned. He’d expected a move like this and hedged currency risk in the majority of the CHF 37 billion ($39 billion) portfolio he oversees at PUBLICA, Switzerland’s largest public pension.
Speaking to CIO at the start of July, Beiner confirmed he was still hedging currencies “in industrialised nations”.
He does not necessarily expect another dramatic decision from his fellow countrymen, however.
“The main reason for this hedge is to eliminate risks from the portfolio that are non-systematic and, as such, not compensated, thereby freeing up a risk budget to exploit other risk premiums,” Beiner explained.
“Currency forwards are used for strategic hedging of the currency risks arising from bond and equity investments in industrialised nations other than Switzerland and to reduce the currency risk to which the portfolio as a whole is exposed,” he adds.
The Other Hedgers
Interest rates—Anders Svennesen, Danica
Everything—Ian McKinlay, Aviva
Everything: Ian McKinlay, investment director, Aviva Staff Pension (UK)
Art by Chris BuzelliOkay, not absolutely everything. But Aviva’s Ian McKinlay—who
is soon
to take over at the helm of Lloyds Banking Group’s £32 billion
pension assets—doesn’t leave anything to chance. If he doesn’t believe his pension
fund can make money from something, it doesn’t make into the portfolio—and in
some cases is actively hedged out.
On top of protecting against volatility in interest rates and foreign exchange like Svennesen and Beiner, McKinlay has also hedged against inflation. In the UK, the Bank of England’s base interest rate has remained at 0.5% since March 2009 and is not expected to rise before the Federal Reserve moves. Inflation has fallen from roughly 5% at the end of 2011 to 0%.
“We use a combination of mainly physical assets, and to a lesser extent derivatives,” McKinlay says. Physical assets used include sovereign bonds, credit, and real assets.
As those who have bumped into him at CIO events in the past can testify, McKinlay deals only in certainties. “We’ve chosen these hedges to protect the mark-to-market risk of funding, and because we don’t believe we can make money in these markets,” he says.
“By doing so we protect the security of accrued liabilities, and seek to harvest sustainable risk premia on real assets,” McKinlay continues. “Boring I know, but we’re one of the best funded schemes around. We also have risk positions in markets where we believe risk is rewarded.”
It is an approach that has served McKinlay well at both Aviva and in his previous role at the Pension Protection Fund. Let’s see if he follows the same path at Lloyds.
The Other Hedgers