Wednesday, April 27, 2005

Pension funds make FX bets

It seems pretty clear to me that in the medium term the dollar will likely decline against a trade-weighted basket of currencies. But, I'm not sure it's a good idea to gamble pension money using FX derivatives. Our current low-return environment is great for hedge funds and advisors - big pools of money are forced to take risk in search of return, and need help doing it.

WSJ: Pension funds traditionally have kept the bulk of their money in U.S. stocks and bonds, where they are among the markets' biggest investors. Only in recent years have they begun to invest abroad. But with bond yields low and stocks volatile, an increasing number of pension funds are turning to the currency market in hopes of boosting their funds' returns.

This interest in currency trades reflects how an aging population and ballooning health-care costs are putting pressure on pension-fund managers to find more creative ways to increase returns. The difficult environment also is compelling many large investors to consider private equity, hedge funds, real estate and other areas they once would have dismissed as inappropriate.

Consultants such as Russell Investment Group, a Tacoma, Wash., firm with $133 billion in assets under management world-wide, are among those urging on the pension funds, saying a currency program offers several unique advantages and should be part of the typical investment portfolio. Since currency wagers are made with derivatives -- financial contracts whose value is based on the performance of an underlying asset -- funds don't need to raise large amounts of money. Currency movements also have low correlations with other markets, helping to reduce a portfolio's overall risk.

...

"Getting a meeting with pension funds in the past was very hard when clients were getting 20% returns from stocks," says Arun Muralidhar, a managing director at FX Concepts, a New York money-management firm with about $12 billion in assets. Now, he says, the firm is in talks with about a half-dozen pension funds that are preparing to hire a currency manager.

Foreign exchange is the world's deepest and largest financial market with a daily trading volume of $1.9 trillion. But paradoxically, it can also be one of the least efficient. That is because as many as three-quarters of the participants aren't dedicated to getting the best possible price, according to Deutsche Bank. These include exporters and importers, foreign stock managers, central banks, even tourists changing money.

International fund managers, for instance, weigh a company's share price, future earnings prospects, and broader economic considerations when determining the optimal time to buy a particular stock. Normally, they are less likely to hurry up or postpone a stock purchase based on how a currency is trading. That creates an inefficiency in the foreign-exchange markets that currency managers can exploit, says Robert Stewart, a portfolio manager for the J.P. Morgan Fleming currency-management group.

The California Public Employees' Retirement System, known as Calpers, is among the pension funds already active in the currency market. Earlier this month, the largest public pension fund in the U.S. received permission from its board to increase the size and aggressiveness of its currency bets. "We are looking into that possibility," says Eric Busay, a fund manager at Calpers.

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