[SYDNEY] Australian pension funds will have to expand the use of foreign exchange hedging as the sector is likely to grow in size to become the second-largest globally with a larger share of investments going abroad, a top central banker said on Tuesday (Sep 16).
In prepared remarks to the board of CLS Bank International in Sydney, Reserve Bank of Australia Deputy Governor Andrew Hauser said the Australian dollar has remained a well-functioning “natural” hedge for global risk assets.
Pension funds, known as super funds in Australia, did increase equity hedges last quarter during a market sell-off caused by the imposition of US tariffs, but Hauser said the pick up was small and market participants reported little expectation of a more material increase in the near term.
The super funds have long kept low foreign exchange hedging ratios on large and growing foreign stock portfolios because the Australian dollar tends to fall with US equity prices, offsetting some of the offshore capital loss.
“Uncertainty obviously remains high, and there is still a great deal of water to flow under the bridge,” said Hauser. But “predictions of the death of the US dollar and the Australian hedging model appear somewhat premature.”
“That could all change rapidly – and the structural trends towards growing super fund balances, much of which will have to be invested overseas, makes it ever more important that super funds in particular scale up their risk management and scenario planning capacity.”
In particular, super funds’ total assets are set to reach 180 per cent of gross domestic product over the next decade, from 150 per cent at present, which could see the sector’s total foreign exchange hedge book double over the same time to A$1 trillion (S$852 billion), said Hauser.
As average fund members get older they are likely to demand greater certainty of return, pushing super fund portfolios away from equity and toward fixed income, which has a higher foreign exchange hedging ratio, Hauser said.
“It is likely that super funds will have to extend and diversify their pool of hedge providers over time to avoid hitting concentration limits. They may also be asked to meet increased margining and collateral requirements on their hedging positions.” REUTERS
