Active vs Passive Debate Moves from Equities to Currencies
If a public pension plan takes a passive approach in one market sector, does it defy logic to take an active approach in a more volatile market sector that carries extreme and uncertain political risks, on top of ordinary day to day market risk?
It appears Calpers is doing just that. We present this concept without looking at Calpers’ underlying foreign currency equity or fixed income exposures and simply raise the question, why would a public pension plan take an active management approach, with significantly greater upfront cash outflow, in a more complex market, to achieve gains with active strategies?
We do not know the
answer, we simply raise a concerning question, that bears debate, as it
is the public’s retirement money at stake.
For the record, transactional or translational currency hedges can be placed without significant upfront costs. The costs of placing hedges are in the bid/ask spread quoted by interbank dealers for spot or forward contracts.
Pensions and Investments, “More Funds Eyeing Active Currency Hedging” (Subscription required) reported on March 17th, “In recent weeks, two big institutional investors — the $286.4 billion
California Public Employees’ Retirement System, Sacramento, and $7.1 billion AUSCOAL Super, Sydney — announced they would shift to dynamic hedging programs from passive ones.”
Dynamic currency hedging is code for speculating in currencies, with hefty upfront fees.
Conversely, Calpers announced in 2013 that it would take a passive approach in the equity markets. as described in this straight forward Marketwatch October 13, 2013 article, “Pension: Calpers Embraces Indexing”
As this article pointed out, Calpers stated in its announcement the move to a more passive approach reflected is core investment belief:
- Markets aren’t perfectly efficient, but inefficiencies are difficult to exploit after costs
Yes, as Michell Tuchman pointed out, in this article:
“1. The sixth-largest pension fund in the world, second in the U.S.
behind the federal employees plan, just endorsed passive investments —
— over paying active managers to attempt to “beat the market.”
2. Cost is the reason why. High active management fees greatly diminish the likelihood of beating the benchmarks.”
We assume Calpers has reviewed the experience of the Kentucky Retirement System (KRS) and Maryland State Pension with the losses incurred utilizing UK based Record. Paying high upfront fees to speculate in currencies is a risk that might not be prudent for public retirement funds.
Hedging currency equity exposures is one thing and may make good sense from time to time, but seeking to gain and speculate on currency movements, while paying high fees to do so, appears contrary to Calpers stated core investment belief, that justified moving to a passive index fund approach in 2013.
In addition, some of the theory of diversification into different asset classes is lost with the hedges. Further, on the fixed income side there is no interest rate advantage, between two countries interest rate differential, after a hedge is placed, and when there is, it is immediately arbitraged. That is a relatively straight-forward strategy for short-term currency traders.
June 28, 2012 “Beware of Currency Managers” at Pension Pulse Blog
March 20, 2012, State Pension System Uses Expensive Currency Management to Reduce Volatility at Marylandreporter.com
While we have not investigated the facts of the Kentucky case, we quote the Insider Louisville here,
“Currencies? Currency arbitrage is the trickiest thing in the
world. Why would a state retirement fund have a position in currency?
We lost $50 million in doing it. And paid them $7
million in fees. Seven millions in fees is why. Kickbacks from that.”