Effective risk management vital for retirement funds in currency war
20 October 2010 | Investments | General | Old Mutual
Brazilian Finance Minister Guido Mantega sparked worldwide concern recently when he declared that a global currency war was underway with emerging market countries fighting to devalue their currencies relative to the US Dollar.
According to Windall Bekker, Manager at Investment Consulting at OMAC Actuaries & Consultants, the currency wars were sparked by low interest rates in the developed markets, which have forced developed market investors to look for returns in emerging markets.
“This means that developed market investors purchase emerging market currencies, which in turn cause the developing market currencies to strengthen against the dollar. This strengthening of the developing market currencies results in emerging market exports being negatively impacted as they become relatively more expensive to the dollar,” says Bekker. “A further consequence of this is that demand for emerging market goods decreases and as a result the emerging markets recovery slows down or stalls.”
Bekker says a currency war scenario presents a number of risks for retirement funds with offshore investment exposure. “In terms of Regulation 28 of the Pension Funds Act, retirement funds may invest a maximum of 20% of their portfolio offshore. For funds making full or even partial use of this allowance, failure to put a proper strategy in place to measure, monitor and manage currency risks, could have disastrous effects for members.”
He says retirement fund trustees can take some practical risk management steps to increase their protection in the event of a currency war.
“The first step is to quantify how much exposure your fund has in total to offshore investments and determine to which markets and currencies your fund is exposed, e.g. US Dollar (USD) vs. Australia Dollar (AUD).
The next step is to identify whether your fund manager has actively tried to manage your foreign exchange risk through the use of derivatives and, if not, why it was decided to leave the exposure unhedged.
Finally, during the trustee quarterly report back, ensure that your asset manager covers foreign exchange in its attribution analysis. This will enable you to quantify the value added or lost through foreign exchange movements.”
