PSPF shuns FX hedging despite dollar losses

The Taiwan dollar has gained 5.5% against the US dollar this year, negatively affecting Taiwanese investors’ returns on greenback-based assets. But the country's two state retirement funds remain wary of currency hedging, despite advisers to their boards suggesting they should make more use of it.

Public Service Pension Fund (PSPF), which does not use foreign exchange derivatives, and Bureau of Labor Funds (BLF), which makes some use of FX swaps, have indicated they do not intend to ramp up their currency hedging. This is despite the fact that US dollar shifts have taken their toll on the institutions' investment performance this year.

Lee Yi-yang, chairman of PSPF’s supervisory board, said at a board meeting in late June that currency volatility would make it difficult for the fund to hit its 2017 return target because of its high foreign allocation, according to minutes of the meeting. As of May 31, overseas assets accounted for 42% of PSPF’s total portfolio, and around half of its foreign assets are in US dollars.

It is likely that foreign mandates this year will not achieve their return target, Lee added, because of the Taiwan dollar's rise against the greenback.

In the five months to the end of May, PSPF returned 1.95% on its NT$572 billion ($19 billion) portfolio, with in-house investments gaining 0.77% and external mandates 3.99%.

One adviser at the board meeting suggested the fund should hedge its foreign fixed-income positions to help improve returns.

Taiwanese investors can only use swaps to hedge Taiwan dollar against other currencies, though they can use forwards for hedging between foreign currencies, said a fixed-income specialist at a local fund house. However, institutional investors in Taiwan seldom hedge their foreign assets, because they have a long investment horizon, said the unnamed executive.

Indeed, PSPF has never used derivatives to hedge its currencies nor in-house overseas investments, a senior executive at the fund told AsianInvestor on condition of anonymity. The fund employs what it calls ‘natural hedging’ for foreign investment, said the individual. That is, it does not use currency derivatives but focuses on diversification to reduce overall portfolio risk.

Moreover, the fund focuses on long-term performance, so has less frequent need than corporates for Taiwan dollar currency conversion, said Chen Shu, acting deputy chairman of PSPF’s management board, at the board meeting.

In any case, he added, the TWD-USD exchange rate is still in a manageable range and hedging also entails high cost and risks.

BLF also wary

Meanwhile, BLF – an umbrella manager for several public funds, with NT$3.7 trillion in AUM – does not intend to make more use of FX hedging in the current climate.

At an April board meeting, the fund, which uses currency swaps for hedging, had discussed the potential impact of a falling US dollar on its foreign investments.

Currency movement is not easy to predict because it is affected by various factors including economics and politics, so BLF will maintain its use of swaps in a "certain range", said Leo Lee, director of the foreign investment division, according to the minutes of the April meeting. 

Zhang Shijie, a supervisory board member at BLF, said at the same meeting that the fund must be careful about hedging, because of both the cost and the potential for a negative impact on returns if it adopted the wrong strategy. 

It is understood that the fund's position has retained largely the same approach to its FX hedging since then.

In BLF’s latest board meeting at the end of June, Lee said that although its foreign investments had achieved capital gains this year, they had been offset by unrealised currency losses. In the five months to end-May, the fund returned 2.33%.

However, Lee noted that the US Federal Reserve had raised interest rates in June and planned to wind down its balance sheet, arguing that these moves would likely push up the US dollar, which should help boost BLF’s foreign portfolio. Indeed, the Taiwan dollar has fallen 1.7% against the greenback between May 22 and July 10.