PIPA 2021: Currency Manager of the Year

Throughout the pandemic, the fundamental drivers behind currency investing remained largely consistent, but the hugely volatile shifts seen within the market over the past year dictated a discourse of unpredictability.

The trend for rising US dollar hedging costs were reversed by the pandemic and subsequent fiscal policy, as the Federal Reserve reduced rates, resulting in falling interest rate differentials and a fall in hedging costs for developed-nation investors.

For sterling-hedged investors, the double effect of the pandemic and ongoing uncertainty over Brexit served to erode some of the overseas gains when markets began to recover during the year.

Markets are now seeing the effects of the Covid-19 pandemic subsiding, with significant opportunities within the currency market. The South African rand, Pakistan rupee and Turkish lira all captured headlines over recent months for their strong performance.

What has become imperative this year is the need for systematic, risk-management orientated approaches to currency investing and hedging with a strong focus on anticipating future post-Covid market conditions.

Our winner stood out for the judges in this category for just this dynamism, helping pension schemes tailor their hedging programmes in order to add value.

Our judges also liked the genuine innovation in this sector, and praised fast responses to changing markets and clients during the pandemic.

Winner: Millennium Global Investments

Commended: Mesirow

Winner - Currency Manager of the Year

MILLENNIUM GLOBAL INVESTMENTS

Last year brought significant volatility to several major currencies after a period of calmness in foreign exchange markets. The US dollar weakened, sterling strengthened as Brexit negotiations moved towards a conclusion, and several emerging market currencies performed exceptionally well in the wake of March’s pandemic-induced turmoil.

In this fast-moving environment, Millennium Global’s flagship Active Currency Alpha strategy performed strongly, posting a total return of nearly 10 per cent for the calendar year net of fees. Its longer-term performance was also strong, the judging panel noted, and demonstrated a good level of risk management.

The judges praised Millennium Global’s “very good innovation”, particularly with regards to environmental, social, and governance criteria within currency strategies. As one judge observed: “Currency markets are not a natural place for ESG considerations but [Millennium] has found ways to innovate.”

The company has developed an ESG scorecard for currencies, which analyses economies on resource efficiency, climate change strategy, healthcare access, human rights issues, and corporate governance standards, among other factors. It has also been building on academic work to quantify how such metrics and factors interact with currency performance and movements.

Elsewhere, Millennium Global has sought to help smaller institutional investors access currency strategies through the launch of a UCITS fund, taking advantage of a boom in demand for foreign exchange solutions.

Charles Goodman
Managing Director
cgoodman@millenniumglobal.com
+44 20 7663 8940

Struan Wight
Head of Client Services
swight@millenniumglobal.com
+44 20 7663 8927

A smarter hedge

Millennium Global Investments’ Charles Goodman sees opportunities in pension funds using dynamic hedging to improve cash flow profiles

How does an active currency mandate impact the risk/return profile of a typical UK defined benefit pension fund portfolio?

Many UK DB pension funds implement a passive hedging strategy that aims to partially neutralise currency risk by hedging a fixed proportion of their foreign currency exposures. An established methodology will typically be in place for determining a strategic hedge ratio that will be reviewed periodically or adjusted automatically if certain levels are reached.

The strong argument in favour of currency hedging is that currencies are a zero-sum game that add risk without adding expected returns.

The inherent drawback of passive currency hedging strategies is the cost of missed opportunities and the occurrence of large negative cash flows in periods of weakness in the home currency.

As such, the main rationale for adopting an active currency management strategy is thus not only to provide better risk-adjusted returns, but also to improve the portfolio’s expected cash flow profile.

An active currency management strategy will take the form of either a dynamic hedging programme, in which the manager will be allowed to vary the hedge ratio on currency exposures within certain constraints, or an active currency overlay programme that will be less constrained and return-oriented. In both cases, the strategic hedge ratio should be the benchmark, and this will remain a key driver of the outcome.

An important feature of currency management is that the opportunity set tends to increase in market regimes that are less benign for the major asset classes. Periods of macro differentiation across countries, incidence of high inflation and/or bear markets for equities can be good for currency strategies. As a result, active currency programmes are particularly relevant and have high diversification potential during such periods.

How can an investor’s environmental, social and governance philosophy be implemented through an allocation to currency?

ESG variables affect the progress of economies and this in turn impacts currency trends and valuations. There are three key transmission mechanisms:

By influencing an economy’s productivity, and hence its growth rate, return on capital and interest rates, which are key to currency trends.
Lack of social cohesion and poor governance may weaken responses in times of crisis.
Through the behaviour of foreign investors, who are likely to increasingly direct capital flows towards countries and investments that are viewed more favourably from an ESG perspective.

We have assessed ESG variables and their impact on economies for many years and used our analysis as an input in our broader assessment of the macroeconomic environment, hence our market positioning.