Currency overlay set to hit $500 billion

Currency overlay, the management of currency exposures in an investment portfolio separate from underlying asset exposures, is set to become a $500 billion dollar industry within the next three years, according to Piero Overmars, Dutch bank ABN Amro’s global head of global financial markets.

Currency overlay, which consultants currently estimate to be worth £110 billion globally, is gaining acceptance among pension funds looking to add returns to portfolios that have been hit hard by depressed equity and fixed-income markets, Overmars told delegates at a pension fund conference in Amsterdam yesterday. As a result, ABN Amro is building up its FX analytics and risk advisory business, which it set up nine months ago to conduct trades and act as an advisory service for currency overlay managers.

Although the currency overlay industry has existed for at least 15 years, there was no conclusive proof that manager strategies were able to capture returns. But studies, released in early 2000 by US actuaries Frank Russell and Watson Wyatt, confirmed the benefits of currency overlay plans and their current work, in tracking manager performance, is also fuelling interest in the industry, said Alfred Bisset, president of Connecticut-based overlay manager AG Bisset.

But, despite his upbeat predictions, Overmars also said the debate about which currency overlay styles are best is likely to continue. One pension fund manager, who wished to remain anonymous, said the confusion over styles can often deter pension funds from signing up to an overlay programme. Broadly speaking, currency overlay managers adopt one of two styles: fundamental managers, such as Dublin-based Lee Overlay Partners, use economic and financial data to make predictions about likely currency moves, while technical managers, such as AG Bisset, use their own models to evaluate currency price data to examine trend and cycles.

Increasingly, however, managers are adopting a hybrid approach to their investment philosophies, noted Paul Duncombe, deputy managing director of State Street Global Advisors in London.

Nevertheless, managers can face difficulties educating pension fund managers about the merits of implementing currency overlay, said Robert Meijer, an Amsterdam-based overlay consultant and former treasurer for Shell Pensioenfonds. “There is an increasing pressure on sponsors and supervisory bodies to reduce overall portfolio risk, but implementation of a programme can take up to two to three years," Meijer said. "Managers have to educate the pension fund board about the merits of a plan and continue to do so once operational,” he added.