Recent problems in the Eurozone have reminded investors just how volatile currencies can be. Michael Fischer asks how family offices are managing their foreign currency exposure.
The global financial crisis raised concerns about foreign currency exposure at family offices around the world, and the market-roiling decline of the euro and sovereign debt problems of recent months have only intensified those concerns.
A newly released survey of high-net-worth families by Massachusetts-based Cambridge Associates found that 37% of respondents wanted more currency management in the aftermath of the financial crisis. Cambridge put the question to its clients in September 2009, and the response was not surprising, says Lindsey Brace Martinez, the firm's director of global client service and relations. "Investors are increasingly placing more of their marketable equities portfolios with foreign asset managers and therefore want to understand how to effectively hedge foreign currency exposure."
Since then, concerns about foreign currency exposure have only increased. "At the moment, everyone talks about unwinding their euro exposure," says Felix Adam, chief executive of ACT Currency Partner AG in Zurich. "European family offices don't think they have enough foreign exposure, while the Americans think they have too much euro exposure. Three years ago, it was the other way around." For Adam, diversification is the answer. "You have to pick some other currencies and other opportunities, like gold."
Discussions with family offices in Europe, North American and Asia turn up a variety of approaches to managing their foreign currency exposure.
"The first thing we do is look through to all the hedge funds and managers we invest in and ask them what their currency exposure is," says Christopher Jackson, president of SFG Advisors, a single family office in San Francisco. "The second thing we do is ascertain where we want that exposure, and whether our current exposure and our goals are aligned. And then we endeavour to move the needle toward where our goals are – in most cases, I think, more than most people do."
Jackson says SFG is not as globally diversified out of the dollar as it would like to be long term – it has a 70/30 split at present, with a goal closer to 50/50. "There's a good case for arguing that your exposure to currencies should be aligned with your expenses to those currencies, so that your assets and liabilities match up," he says. "And people have taken as a rule-of-thumb that 70/30 is probably close to what the liability side of your balance sheet looks like. But I would suggest we are probably making a more active bet, and therefore we have the goal of leaning harder into emerging markets and growth areas of the world and have a greater expression to those countries that are positive cash flow."
Frederick Shepperd, managing director of Shepperd Investments AG, a single family office in Zurich, says his base is currently the US dollar. "I'm in Zurich, so I'm sort of in between. I have my cost base in Swiss francs, but with the dollar down before, I was trying to get things done in euros and other currencies. Now I am going back to the dollar and am doing more business in the US."
Shepperd Investments tends to move carefully with the major trends of the currencies, and to anticipate what those trends are going to be so that it is ahead of the curve, he says. "My strategy is to get more earnings out of North America, get invested with other entities in dollar-based assets, and then use that base to go into developing opportunities in Europe with the euro."
Other European family offices are doing the same thing, he says. They are not just rapidly going to dollars, but are certainly looking to the US market to invest, to get dollar-based assets they can better turn to go in the other direction.
Shepperd's US dollar investments include real estate, oil and gas, and private investments in companies. In the Eurozone, he sees developing opportunity for real estate. "Prices are softening, people are looking to sell to avoid the drop that's coming," he says.
Heinz Blennemann says there are two reasons for currency hedging at Blennemann Family Investments, a single family office in New York. "One is that we like to preserve our purchasing power. We buy things overseas, and we plan to do so in the future; so we like to hold multiple currencies. Two, we like to diversify risk, so holding multiple currencies allows us to diversify against geopolitical risk.
"We do not believe there will be long-term appreciation in our currency investments. I think people understand that the expected value of just holding currency over the long term is zero. We're aware of that, but we do it for the other two reasons."
Blennemann uses a bottom-up approach to decide how much foreign currency exposure to have in his portfolio. "Whatever we buy internationally for our asset allocation, we just leave that in the foreign currency – in order to get the return. If I do a simple calculation, about 66% of my equities are international and about half of my portfolio is equities; so then I should have about 30% in foreign currencies not hedging."
To implement this, he says he executes a bit differently from other people. "We're very tax sensitive. Instead of saying we need more foreign currency exposure, so let's buy more foreign-denominated bonds, we buy municipal bonds, whose interest is not taxed, and then we go into the forex market and buy futures. That's how we get our 30% exposure." The family office has been doing this for a few years, he says.
"We have been dollar based since the beginning of the year as we felt it would be going up so we actually sold euros," says Deepen Ram, a member of a multifamily office group in Geneva.
At present, he says his organisation is invested about 70% outside the euro, 30% in the euro. "Out of that 70%, we're probably 60% in US dollar, and then the rest is Swiss francs and yen. We also recently sold Australian dollars to buy yen and Swiss francs."
Ram says his firm does currency structured notes and some capital guaranteed notes. For diversification, it has bought a lot of bond funds. It still has equity exposure, but that has been reduced from some 60% down to around 30% today.
Hedge funds are considered the best approach to manage the long-term assets against the long-term liabilities of Hong Kong-based Search Investment Group, the family office of Robert W Miller, a founding shareholder in Duty Free Shoppers. The reason for investing in hedge funds is to avoid any kind of beta exposures, says Vincent Duhamel, chief executive of SAIL Advisors Ltd, the group's investment arm.
"You're not trying to hedge your liabilities by using beta positioning. You just try to capture the alpha being generated by top-notch managers. You don't want to get the directions of the market; you want to be market neutral. By doing this, you will naturally be able to hedge out the kind of foreign exchange risk that you have over the long term. We don't worry about what the euro is doing this month. As a matter of fact, we don't care what the euro is doing."
Duhamel acknowledges that some short-term hedging may be called for to match short-term expenses. "Other than that, it's quite speculative to try to hedge out long-term risks on currencies."
According to Chris Turner, head of strategy at Lombard Street Research in London, many investors currently have the same view in terms of favouring certain emerging market currencies over the developed market and within the developed market, favouring currencies outside the G3 or G5. "That's fine, because on fundamental grounds that's the right thing to do," he says. "The only problem becomes one of liquidity. When markets become illiquid, there can be quite a sharp fall in some of the peripheral currencies."
Turner says that in the present environment, it makes sense to think of gold as a default currency. "We tend not to think of it as a hedge against inflation as such, but more as something to go to as a disaster hedge almost. With the focus on sovereign debt problems, none of the major economies are immune from that viewpoint. We see the global economic environment as one where deflation is more likely than inflation in the near term, certainly in the US and Eurozone, and that will encourage central banks to stay pretty loose in terms of their monetary policy, which will probably give a boost to inflationary expectations further out even if inflation takes a long time to pick up. So gold should benefit from those expectations even in the deflationary environment."
What about currency funds to manage exposure risk? Turner says currency funds are harder to buy than equities or bonds because they resort to a vast list of fundamental factors that may affect the currency, but quite often do not.
"The best currency managers have proved that a combination of fundamental process together with some more quantitative overlay can actually produce good returns over time. But it's probably a situation where the number of people doing it well is fairly small."