The New York Teachers Retirement System is considering implementing a foreign currency hedging strategy to decrease risk and boost returns.
At the pension fund’s monthly investment meeting, held Thursday in New York’s Financial District, its deputy chief investment officer of public and tradable securities, Michael Haddad, and chief risk officer Miles Draycott presented a potential process for hedging foreign currency investments to the board of trustees.
“The question that we’ve posed to ourselves, and that we’re drawing you into the debate: is it appropriate to not hedge foreign currencies?” Haddad said in the meeting.
At present, New York Teachers has roughly 19 percent of its portfolio invested in “non-dollars,” Draycott said. The bulk of those investments are in developed markets, though some are emerging market investments, he noted.
Draycott acknowledged that while currency hedging reduces volatility, “the cost of hedging reduces return.” To get around that, the fund could increase risk in other investments that may be potentially more profitable, which in turn could result in a higher return, he noted. While the cost of hedging emerging markets currencies likely wouldn’t pay off, doing so in in developed markets outside of the United States likely would, he added.
“We feel that hedging allows you to have a more efficient portfolio,” Draycott said. “On average, it increased the return to hedge.”
CalPERS at one point passively hedged currency investments, but according to Draycott, it abandoned those measures too soon.
“They had losses; they pulled the plug at exactly the wrong time,” Draycott said. “Now they are looking at putting a hedging program in place again.”
It’s been a while since New York’s pension plans hedged currency risk in this manner, and Draycott advised that the pension plan should take time to consider whether the move would be appropriate.
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One board member, Thomas Brown, was skeptical. He likened a currency hedge to paying a fee to ensure that when traveling to Europe over the next ten years, his dollar-to-euro exchange rate would remain the same.
“Convince me that I should pay this travel company a fee to just protect my dollar value when over the last ten years it seems to equal out,” Brown said.
Joe Nankof, a consultant at Rocaton, which works with New York’s retirement systems, interjected.
“It’s the nature of insurance,” he said. “If it’s cheap enough, pennies on the dollar, it’s worth it.”
Draycott agreed. “The whole thesis here is that by hedging you can create a more efficient portfolio,” he said.
Whether or not the fund chooses to hedge currencies will be determined in the coming months. The fund plans to discuss it at either its October or November investment meeting.