The 2021 NAB Superannuation FX Hedging Survey finds Australian funds signalling their intention to further increase offshore investing levels, raising the spectre of increased currency risk.
The biennial survey, the 10th by NAB, captured responses from funds with over AUD 1.8 trillion in assets under management, a significant proportion of one of the world’s largest superannuation pools, which Deloitte’s predicts will rise to $4.7 trillion by 2030.
The survey finds that the internationalisation of Australian superannuation funds’ investment portfolios has accelerated, they now have on average 46.8% of their assets offshore, up from 41% in 2019 as they search for further diversification and attractive returns.
The trend looks set to continue, NAB finds, with 61% of funds saying they will increase the share of international assets in their portfolios in the next two years. In terms of the specific asset classes funds will target offshore, listed equities figures most prominently followed by unlisted infrastructure and listed property. Alternatives, unlisted property, fixed income, and listed infrastructure also rated mentions.
Overall, funds are hedging more of their international equity exposures than in 2019. Even so, NAB says despite the sharp fall that occurred in the AUD in early 2020, overall hedge ratios remain relatively low, which it believes reflects the long-held view that running long foreign currency exposure will act as a diversifier during major ‘risk off’ events.
At the same time, the trend by funds to view currency through the prism of a desired foreign currency target has continued, with 72% of respondents now looking at currency risk in this way rather than via a traditional hedge ratio. The average desired target is 21.5%, the survey finds. More funds want to view currency risk using the same lens as they view other asset allocation decisions, NAB says. Interestingly, it adds that more funds took advantage of the collapse in the AUD at the start of the pandemic, to increase their hedging ratios, suggesting a more opportunistic and proactive approach to currency hedging.
Emerging markets in general and China in particular, are frequently mentioned by funds as important investment destinations, yet there remains no consistent approach to hedging emerging markets exposure. More than half of funds (57%) do not hedge any of their EM exposure, despite increasing allocations to these markets, while of the 43% of those who do hedge at least some of their underlying exposure, close to three-quarters hedge 50% or less of their equity risk. In contrast, most funds with investments in EM fixed income operate with a relatively high currency hedge ratio – typically, 75-100%. Some funds also report still using developed market currencies as a proxy for their EM hedges.
The trend to giving investment teams more responsibility in making and implementing currency decisions continues, while investment committees and boards focus on strategic decisions and monitoring the performance and effectiveness of the investment strategy. Some 64% of funds said the investment team is most influential in FX decision making, followed by investment committee and then their asset consultant. While funds continue to review their currency hedging policy annually, currency exposure is being reviewed much more frequently than was the case in the 2019 survey. “We conclude from this that currency decisions have assumed more importance, as highlighted during the period of extreme currency volatility in 2020, as well as the increased focus of funds on target currency exposure,” NAB says.
An emerging theme in this year’s survey is the impact of regulation. Funds expect the Australian government’s new Your Future Your Super (YFYS) framework to lead to much greater scrutiny and ongoing monitoring of the impact currency risk is having on their performance relative to APRA’s performance metrics.
Currency risk is often cited as the second largest portfolio risk, after equities, in a multi-asset portfolio and NAB says small funds indicated they were more likely to keep currency exposures close to their Strategic Asset Allocation (SAA) to mitigate tracking error versus the APRA (Australian Prudential Regulatory Authority) benchmarks. Not unexpectedly, funds with strong past relative performance felt they had more scope to continue with their current approach to managing currency exposure, notwithstanding the increased focus on the APRA performance matrix.
In terms of expectations for Australian dollar performance over the next year, NAB says that no strong consensus emerged, however there was a slight bias to the upside. Ray Attrill, head of FX strategy at NAB, pointed out in presenting the results, however, that the survey was taken during a period when the AUD was at the lower end of recent ranges and looking cheap on a valuation basis. While FX forwards, particularly in the three month tenor, remain the most popular hedging method, NAB says the survey also highlighted increased interest in using NDFs and FX options.
The Full FX View
The interesting aspect in this survey is how it does not correlate with the semi-annual FX turnover surveys, particularly that one from the Reserve Bank of Australia. Recent years have seen FX volume in Australia flatline and they remain well below levels of a decade ago – yet funds are investing more offshore. This suggests that either the Australian banks are losing market share – and the trades are being booked in offshore centres – or they are waiting for more liquid markets in Europe before hedging.