The way superannuation funds approach currency hedging is somewhat arbitrary and could well be adding tail risk to their portfolios, according to risk modelling firm Axioma.
Speaking to InvestorDaily, Axioma's managing director for the Asia Pacific, Olivier d’Assier, said the “standard methodology” for superannuation funds is to apply currency hedging to half of their portfolio.
“If you don’t have the tools to aggregate the risk across your asset classes, you have no idea if the exposure that you have in various currencies is diversifying or increasing the risk you have in other asset classes,” Mr d’Assier said.
Based in Axioma’s Singapore office, Mr d'Assier is currently shopping the firm’s multi-asset risk modelling solution around to institutional investors in the region.
The Axioma platform gives investors the tools to measure aggregate risk across their portfolio, as well as the effect that hedging one asset has on the rest of the portfolio, he said.
The problem with choosing to “just hedge 50 per cent” or “just hedge 100 per cent” of an exposure is that super funds “don’t know if it’s helping them or not”, he said.
“If you’re using derivatives to hedge your currency exposure you’re trading currency exposure risk and currency volatility for counter-party risk – in addition to not being able to roll over your hedges on time,” he said.
Liquidity risk is another tail risk that could eventuate from such a strategy, Mr D’Assier added.
“So when you have a crisis like the GFC and liquidity dries up and your counter-parties go bust, suddenly your hedges are no longer valid and you lose twice as much as you thought,” he said.
MTAA Super was a notable example of a super fund that got its currency hedging strategy wrong during the GFC, losing substantial amounts of money via its derivatives exposure.
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