2015 NAB Superannuation FX Survey

Transcription

1 2015 NAB Superannuation FX Survey Tuned in to a changing AUD AUD depreciation Changing exposure Hedge ratios Dynamic management Regulation and counterparties

2 Contents Foreword and methodology Key findings 4 The changing AUD is making its mark 5 Fund asset level stabilising 6 International equities the swing factor 7 Performance of hedged, unhedged and partially hedged (equity) funds 7 Emerging markets continue the equities theme 8 Proxy hedging 9 Less hedging in international fixed income 9 Smaller asset classes saw a rise in hedges 10 Infrastructure FX exposure drops 10 Setting the strategy 11 Dynamic hedging 12 Tilting not as popular 12 Currency is important 13 Management of FX hedging 14 Market volatility 15 Regulation and counterparties 16 Counterparties and tax treatment 17 Regulatory change impacts 17 Use of products 18

3 Foreword and methodology By Drew Bradford, Executive General Manager of Fixed Income, Currencies and Commodities, NAB We re pleased to present the 2015 NAB Superannuation FX Survey. As superannuation funds in Australia continue to grow, and with volatility increasing in global currency markets, understanding trends in offshore investment and foreign exchange hedging is critical. The purpose of this survey is to provide clarity about how Australian super funds manage currency particularly in response to a changing Australian dollar. This includes looking at their behavior in relation to hedge ratios, decisionmaking processes, use of service providers, counterparties, hedging products, regulatory change and other issues. In 2015 we conducted our 7th survey, held every two years since 2003 (with data back to 2000). It is the only survey of its kind in Australia, and continues to expand. In 2015, 40 funds responded, representing around A$682 billion in funds under management, compared to 64 funds and A$650 billion in The survey is conducted across the spectrum of profit for member funds, but also includes funds responsible for managing assets invested to meet future pension liabilities in the public sector. It excludes SMSFs, retail funds and funds that are on master trust and other platforms. Fund responses are based on the investment option with the greatest overall fund balance in most cases the default fund. This year the survey interviews predominantly took place between 1 September 2015 and 6 October 2015, when the AUD traded between and Since the survey in 2013, the AUD has depreciated 13% on a trade weighted basis and against the USD it is off 22%. However, since the 2003 original survey it has seen its post float (1983) peak and subsequent reversal. This has given funds plenty to think about and an almost complete cycle in which to manage their FX exposure. The survey involves in-person interviews with senior investment professionals, and we are grateful for their time, attention and support. Without this broad participation and commitment this survey would not be possible, or as complete. Our aim with this survey is to make a contribution to the superannuation industry and trust that you find the report useful. 3

4 Key findings The 2 decline in the AUD since 2013 has corresponded in a rise in average FX exposure at the overall fund level to 24% in 2015, from 18%. The level of overall FX exposure for industry funds has risen significantly to 28% from 18% in 2013 and for corporate funds to 2 from 17%. The management of currency exposure between fund and asset level held relatively steady with an almost 50:50 split. There was a significant rise in FX exposure in international equities and international fixed income, with a decline in exposure to infrastructure, international property, private equity and hedge funds. The percentage of funds allowing for FX exposure greater than 75% in international equities moved from a historical low of 2% in 2013, to a high of 25% in FX exposure in emerging markets rose to 44% in 2015 from 25% in Funds which do have emerging markets exposure choose to use a proxy. This has been challenging in the current volatile markets. The hedge ratio for fixed income fell to the lowest level in the survey s history, with on average 72% of funds hedged in fixed income, from 94% in In 56% of funds, the investment committee now has the most influence on currency issues, back to 2005 levels. Respondents reviewing currency issues on a monthly basis has risen strikingly, to 24% from 5% in the last survey. We ve seen a rise in the use of dynamic hedging in international equity exposure, to 17% of funds in 2015 from 8% in % of respondents believe that no one can predict where the AUD will be in two years, although 63% believe the AUD will continue to fall in the next two years. 73% of funds use a currency specialist but passive hedging remains the dominant approach to FX management. Use of cross currency swaps is down to 15% from 2 in 2013 while FX options saw a greater decline in use to just 7% of respondents, from 27%. * An examination of the MSCI World (xa) Index returns 4

5 01 The changing AUD is making its mark Against a backdrop of significant Australian dollar (AUD) volatility a key theme quickly emerged from the 2015 NAB Superannuation FX Survey: Australian super funds are responding to the changing trends in the AUD and targeting how they address those issues. With the AUD declining by almost 2 since the 2013 survey, and around 35% since its 1.10 peak in July 2011, it s clear that foreign exchange (FX) should, and does, remain a clear issue for funds. The decline in the AUD/USD, both against the USD and on a trade weighted basis (TWI), is reflected in the rise in FX exposure (i.e. those assets which remain unhedged versus hedged) at the overall fund level. In 2015, funds had an average exposure to FX of 24%, compared to 18% in 2013 and 17% in Chart 1: Decline in the AUD Index AUD TWI (lhs) AUD/USD (rhs) AUD 85 Jan 15 Feb 15 Mar 15 Apr 15 May 15 Jun 15 Jul 15 Aug 15 Sep 15 Oct Source: Bloomberg 5

6 There was a large rise in the level of overall FX exposure for industry funds (to 28% from 18% in 2013) and for corporate funds (to 2 from 17%), but government funds were the outlier, experiencing a small decrease in FX exposure (to 16% from 19%). However, if we look at where that FX exposure is being enacted, there is a clear preference for specific asset classes, rather than an increase in FX exposure across the board. There was a significant rise in the FX exposure in international equities and international fixed income, but there was a decline in exposure to infrastructure, international property, private equity and hedge funds overall. There appears to be a preference to raise exposure in the asset classes with greater funds and raise hedge ratios (decrease FX exposure) in the asset classes with lower asset allocations. Emerging markets are the exception. Table 1: % FX exposure overall Fund type Corporate - 17% 2 Government - 19% 16% Industry Funds - 18% 27% Total 17% 18% 24% Fund versus asset level stabilising This, of course, is for those funds that are managing FX exposure at the asset rather than fund level. Those allocating at a fund level also saw a rise in FX exposure, but do not show any split between asset classes. The management of currency exposure between fund and asset level held relatively steady in the 2015 survey. It appears that the trend away from managing at the asset level and towards managing at the fund level, may have completed its course (for now), with an almost 5 split. The difference in the 2015 survey from the 2013 split was not statistically significant. The change has come a long way from the initial difference (in 2001) with 91% at the asset level and 9% at the fund level. It may be that mandate constraints have slowed progress, and there may be incremental changes in the years to come. But many who could and wished to do so may have already made the change. Chart 2: Fund level hedging versus asset level Asset class Fund level There was a significant rise in the FX exposure in international equities and international fixed income. 6

7 International equities the swing factor Chart 3: Changing FX exposure across assets The rise in FX exposure at the international equities level is an interesting one. This asset class appears to be one of the swing factors for funds in response to changing trends in the AUD. 1 6 International equities International property Private equity International fixed income Hedge funds Emerging markets Infrastructure The percent of funds that allowed for FX exposure of greater than 75% in International equities went from an historic low of 2% in 2013, to a high of 25% in As such, 25% of funds decided they would leave much of their international equities unhedged in order to take advantage of the expected decline in the AUD Compare this to the lows of 2-3% in the 2009, 2011 and 2013 surveys, where the environment was (or had recently been) one of a rising AUD and advantages to the fund of having less FX exposure (more hedging) were greater Performance of hedged, unhedged and partially hedged (equity) funds Looking over the past decade, the rationale for hedging and the direct benefit, in terms of outperformance against remaining unhedged, has not remained constant; this has become much clearer in the last few years as the AUD has depreciated. If we concentrate on the last full 10-year period and consider the currency contribution to the MSCI World excluding Australia Index, fully hedged returns have outperformed unhedged returns, 6.8% versus 5.6% respectively (in annualised terms). Hedging over the decade would have provided a positive return, but the difference has narrowed to only 1.2ppts. Chart 4: MSCI xa hedged, unhedged, 5 hedged 150 Hedge Hedge 10 Hedge MSCI xa Index in AUD 90 (Total Returns net dividends charted) 80 MSCI xa Index Hedged in AUD (Total Return net dividends charted) 70 Jan Jul Jan Jul Jan Jul 13 Apr 13 Oct 14 Apr 14 Oct 15 Apr 15 Oct Source: MSCI Barra, Bloomberg, WM Reuters However, if you held foreign equity investments over the last two years, both the 10 and 5 hedge impacts are negative for the period. The return from unhedged MSCI World ex Australia investment was 20.2%, fully hedged 11.6% and 5 hedged 15.9%. This means that a superfund would have been behind by 8.6ppts (in annualised terms) by being fully hedged and 4.3ppts by being 5 hedged. This highlights that not adapting your currency hedging, and maintaining high hedge ratios which have benefitted funds in the past, especially against the backdrop of a depreciating AUD/USD, may not lead to more consistent performance. This has, perhaps, led funds to be more dynamic in their currency decisions of late (discussed further on page 12). Chart 5: MSCI xa hedged, unhedged, 5 hedged varied returns Performance of MSCI excluding Australia Index in unhedged AUD (LHS) Performance of MSCI excluding Australia Index Hedged 10 (LHS) Performance of MSCI excluding Australia Index Hedged 5 (LHS) 10 Hedge Impact (RHS) 5 Hedge Impact (RHS) 25% 2 15% 1 5% Sep Sep 2015 Sep Sep 2013, Reuters Sep Sep % -2% -4% -6% -8% -1 1 Note that there is a small revision to prior history for the asset class results due to a minor change in methodology to ensure consistency across surveys. 7

8 Obviously, in 2013 the AUD was already on its way down, dropping from the 2011 high of to the 0.90s. Indeed, at that time 67% of respondents reported that they believed the AUD was likely to be lower in the forthcoming two years. But in 2011, only 52% believed that the AUD was moving lower, and this may be the reason that by the time the 2013 survey came around they had not yet fully reflected the AUD s decline in their hedging strategy that is, through reduced hedges. Funds can be slow to respond to changes in FX value, a key issue we will examine when we consider how often FX is reviewed. In 2015, most funds were 26-5 exposed to FX in international equities, which was also the mean in However, there was greater dispersion of hedge choices in 2015 compared to More funds also employed dynamic hedging and fewer were exposed in the lower 1-25% band. This is consistent with the desire to have greater FX exposure in general. Chart 6: International equities dispersion of exposure % % Dynamic After two survey periods of reduced FX exposure, in 2015 there was a pick-up in the level of FX exposure in emerging markets. Emerging markets continue the equities theme As with international equities and fixed income, emerging markets shows a similar pattern. After two survey periods of reduced FX exposure, in 2015 there was a pick-up in the level of FX exposure in emerging markets. The level of FX exposure in this asset class (of those who do have it) remains well below that of international equities, at 44%, but it is above the 2013 low of 25%. The increase was seen across all fund types, with the largest increase seen in corporate funds. At 44%, the overall level of exposure remains a little below the levels in early surveys and suggests that there may be room for increases ahead. In further questioning on emerging markets, it remains clear that 44% of respondents do not have FX exposure at all in this asset class. The splits between equities and fixed income reflect the broader market, in that there is a higher degree of hedging in fixed income compared to equities. The largest cohort for fixed income (17%) was in the hedging range, while equities saw most hedging (15%) in the 1-25% range. However, in both categories, for those funds that do have emerging markets currency exposure, many chose to use a developed market proxy to manage their currency exposure: 17% in equities and 2 in fixed income. Chart 7: Use of hedges in emerging markets 5 45% 4 35% 3 25% 2 15% 1 5% No 1-25% Equity Fixed interest Dynamic Proxy with developed currencies 8

9 Proxy hedging Using a currency proxy poses an interesting challenge under current market conditions. There has been a substantial amount of currency (and other market) volatility. This has been particularly pronounced in the emerging markets and their currencies. In many cases there has been a depreciation of the emerging market currency, which is not fully captured by its proxy. For example, the Brazilian real (BRL) had depreciated ~46% against the US dollar (USD) by the end of October A common proxy for the BRL would be the USD (for an Australian fund). So while AUD/BRL has appreciated ~32% since January, AUD/USD has depreciated ~11%. Consequently, if the BRL was being proxied with the USD, there would be a mismatch in the hedge. This mismatch raises questions about appropriate proxies for emerging market currencies. Proxies are a useful tool to access more liquid markets and reduce transaction costs, but with higher volatility levels there are greater risks of performance mismatches. Given this, perhaps there will be less proxy usage in future, or an alternative which looks to use more highly correlated, and perhaps more liquid, emerging market currencies as proxies. Chart 8: AUD/BRL versus USD/BRL AUD/BRL USD/BRL AUD/BRL (lhs) BRL/USD (rhs) Jan 15 Feb 15 Mar 15 Apr 15 May 15 Jun 15 Jul 15 Aug 15 Sep 15 Oct Source: Bloomberg Less hedging in international fixed income The 2015 survey also reflected a rise in FX exposure in international fixed income. The latest results show a decline in the hedge ratio for fixed income to the lowest level in the history of the survey. In 2015 funds were, on average, 72% hedged in fixed income, down from 8 in the prior survey and a high of 94% in As with international equities, this follows the trend patterns of the changing AUD. Within the headline decline in FX hedging there was some dispersion. Government funds showed the 10 hedged stance that is often thought of when talking about this asset class. At the other end of the spectrum was the 63% hedge ratio held by the industry funds. Corporate funds were in between, at 94%. The low level associated with the industry funds appears to be an anomaly and may be associated with this year s particular sample. Overall, it s interesting to see this dispersion through the funds. But is it a fundamental change? It will be interesting to see how this develops in the next survey. It s usual to see very high hedge ratios in this asset class. However, if some funds are seeing returns from reduced hedging, then it s certainly practical to do so (and make an impact at the total fund level) via the larger asset classes. If this is the case, then it may be reflected in future surveys. 9

10 Smaller asset classes saw a rise in hedges In contrast to the rise in FX exposure in the larger asset classes, there was a rise in the hedge ratios (lower FX exposure) for the smaller asset classes: international property, private equity and hedge funds. This was relatively pronounced in private equity, where the hedge ratio rose to 8 on average, from 51% in This was consistent across the sectors, with a rise in corporate, government and industry funds hedging activity. The hedge ratio in international property rose, but just back to levels seen in prior surveys. A similar pattern was seen for hedge funds. Table 2: Hedge ratios in smaller asset classes Infrastructure has been highlighted specifically in the last few surveys. This is a strengthening asset class and important for FX hedging, as there is a subtle change occurring from a focus on domestic towards international assets. If anecdotal evidence is correct, more funds are searching for accessible assets, irrespective of their domicile. If assets are less available in Australia, then the search increases offshore. This is highlighted by the fact that 56% of funds had no preference for where their assets were domiciled. In the funds which did have infrastructure assets, the allocation to domestic infrastructure has been modestly declining; from 31% in 2011 to 29% in Meanwhile, there is a steady increase in preference for international assets, which has risen from 5% in 2011 to 15% in Table 3: Preference of location for infrastructure assets International property % 8 76% 87% 6 81% No answer 2% Private equity 41% 59% 66% 52% 51% 8 Hedge funds 72% 69% 86% 77% 68% 79% Domestic 31% 3 29% International 5% 11% 15% Infrastructure FX exposure drops The other smaller asset class to experience a drop in FX exposure was infrastructure funds. This returns FX hedging to the 2011 and prior levels around 77%. It seems that the reduction in 2013 may have been a temporary low. Chart 9: FX hedging in infrastructure No preference 64% 58% 56% The latest survey showed that 33% of funds had increased their funds under management (FUM) in infrastructure. While assets were around 0-4% of FUM for 44% of funds, a number of respondents suggested that this was because they had scope to invest but had yet to find the desired assets. Forty one percent had 5-9% of FUM in this asset class Corporate Government Industry Funds TOTAL Infrastructure is a strengthening asset class and important for FX hedging, as there is a subtle change occurring from a focus on domestic towards international assets. 10

11 02 Setting the strategy In making the decision to change the hedging strategy, the 2015 survey clearly shows a rise in the importance of the investment committee, and a strong but modestly lower consultant influence. Boards and fund managers still have a small say. The influence of the investment committee has returned to the heyday of the 2005 survey, having the most influence on currency issues in 56% of funds. This compares with a low of 42% in Chart 10: Influencers in decision making Other Investment committee Fund manager Consultant Board of trustees It s not surprising to see this change, given the increase in volatility in markets and the likely rise in the need to be more flexible, nimble and have a faster decision making process. Many funds responded that the investment committee had the most influence, but that these decisions were endorsed by the board. The rise in the requirement for a more nimble approach is backed up by the response to the questions about the frequency of addressing currency issues. Most are doing this annually with 37% of funds saying that they looked at this issue once a year, down from 55% last survey. But it is the significant rise in the number of respondents who are now reviewing currency issues on a monthly basis that was particularly striking. This has risen from 5% in the last survey to 24%, while those reviewing quarterly rose to 27% from 2. It s clear that there is now a greater dispersion of currency review timing, which raises the overall frequency of funds addressing currency issues. 11

12 Dynamic hedging The rise in the use of dynamic hedging is also a response to higher market volatility and a desire to respond more quickly to changing market conditions. There was an increase in the use of dynamic hedging in international equity exposure from 8% in 2013 to 17% of funds in This is consistent with the response to the question, how often do you move your currency hedge? Respondents also noted a large rise in the use of dynamic changes in hedges, from 44% in 2013 to 51% in This was the most frequently used method of changing currency hedges across both years. Similarly, those who responded that they changed their hedges less frequently fell to 27% from 34%. Table 4: Timing of changes in hedges Tilting not as popular The 2015 survey showed a decreased preference for currency tilting maybe because the hedging decisions are now more dynamically changed. Tilting is a hedging policy whereby funds may change their actual hedges by a pre-determined range around the desired central hedging ratio. This is often done in response to changes in currency value, which may or may not be viewed as temporary. One example of tilting being used is to move in a limited way around a central benchmark (i.e. those who are tilting in the 1-9% cohort): if the AUD/USD is expected to decline on a long-term basis then a strategic hedge ratio decision has likely been made. If a tilting policy is in place, and the AUD/ USD suddenly appreciates and it is deemed a temporary appreciation funds can temporarily lower the hedge ratio until the AUD/USD drops back to its expected path. When the AUD subsequently moves lower, the hedge ratio is returned to the strategic level. This would take advantage of the returns gained from the AUD s drop back after its temporary spike No answer 2% Dynamically 44% 51% Bi-annually 6% 2% Annually 9% 17% Less frequently 34% 27% Never 5% 2% Total Table 5: Tilts around a strategic allocation to FX % 7% 14% 10-14% 7% 26% 15-19% 2% 5% 20-24% 4% 13% % 11% >5 58% 31% Total

13 In 2013, 63% of respondents were utilising tilting, but this dropped to 54% in the 2015 survey. Of those who responded that they used the method, there were a greater proportion of government funds which did, while corporate funds used this method the least. The drop back to 54% might be a by-product of more funds using more nimble dynamic hedging policies to address the rise in market volatility and the change in desired hedging levels, rather than tilting around a set range. Of those who said they do use the policy, a large percentage (31% from 58%) were tilting >5 around a set level. This also supports the idea that those who are no longer tilting are using dynamic hedging, as being able to move >5 around a central benchmark is a relatively large amount of leeway for a tilting strategy. Alternatively, this may be a passive change in hedges associated with meeting different levels of the AUD. Those who are still using tilting in 2015 are increasingly using the more traditional idea of the method, with a large rise in those using tilts of either 1-9% (to 14% from 7%) or 10-14% (to 26% from 7%) these are modest shifts around the strategic asset allocation rather than wholesale changes. Currency is important As in the 2013 survey, currency hedging issues were considered important and marginally important. This was not as strongly felt in 2015 compared to the prior survey, but it remains the most dominant theme in funds approach to FX hedging decisions. Chart 11: What is the most important issue in hedging? 13% 3% 3% 5% 26% 51% Change in value in currency rate Higher overseas investment allocation Consultant recommendation Peer group choice of benchmark Concern about cash impact of hedges Change in fund manager Other factors that remain important for funds include higher overseas investment allocations. The importance of this factor has dropped marginally compared to prior years; it was the number one for only 26% of funds. In 2015, higher overseas allocation was enough to provoke a change in hedging policy for 56% of funds, down from 64% in the last survey. It is most important for corporate and government Funds, less so for industry funds. Consultants remain a key influence in making hedging decisions, with 68% of funds suggesting that their recommendations would prompt a change in their hedging policy. This was most influential for corporate funds, and modestly less so for government funds. Of the issues that funds felt were the most important for their hedging decisions, most were concerned about the change in the value of the currency. Considering that the AUD/USD has moved -11% since the start of the year, and is down -9% on a trade weighted basis, this is not surprising. A change in the AUD was the most important factor in making changes to hedging for 51% of funds, and enough to provoke a change in hedging for 63% of funds; down from a peak of 88% in The 2015 survey highlights that when the AUD moves significantly, it s likely that fund investment committees are looking at their hedging decisions and possibly looking to make a change in hedging levels. This should not be a surprise! But it seems that funds are more able to work in this manner, at this time, compared to other periods in the survey. Of the issues that funds felt were the most important for their hedging decisions, most were concerned about the change in the value of the currency. 13

14 Management of FX hedging Most funds were pretty content with their present currency management execution, with 9 saying that they are not looking to change. An equal number (5%) were looking to either insource or outsource their currency management. Slightly fewer respondents in the 2015 survey now use a currency specialist to implement their currency strategy: 73% said they did, compared to 88% in the prior survey. Of those who do use a specialist, 76% say they use a currency overlay manager; this too was a little lower than in the last survey (81%) but it appears that the higher numbers in the 2011 and 2013 surveys were the outliers. Of the currency overlay managers that were used, the majority remained passively managed, with only 17% (the same as the 2013 survey) being actively managed. Those funds that are using active management techniques are doing so to see additional returns. But the conviction isn t high, with many choosing not to answer. We come to the crux of the matter with the passive managers. The vast majority believe that active management does not enhance returns (34%), which is similar to prior years. A number believed that they could not value the active management, so didn t do it. Don t know so don t actively manage The attitude to active management is entirely consistent with the dominant view that no one can predict where the currency is going over a 12-month period. As disappointing as this is to a currency strategist, it seems to be the prevailing view. Some 76% of survey respondents said that nobody could predict where the AUD would be in two years. In slight appeasement to the research team, 2 did say that currency specialists/researchers were best placed to predict the currency (slightly higher than in the 2013 survey) but still well below the nobody mood. But many have a view Despite the view that nobody can predict the currency, each respondent in the 2015 survey had a view: and 63% believe the AUD will continue to go down over the next two years. A slight increase on the last survey (2) said they saw no change in the AUD, from 16%. However, what was interesting was the increase in those who now see an increase in the AUD/USD over the coming two years. Approximately 17% now see a rise in the AUD in the years ahead, up from 9%, highlighting an increase in dispersal of views. This is surprising in the context of the broad market bearishness on the Australian dollar at present. Measures of market views show the IMM speculative traders remain quite short, while measures of net fund flows also show outflows in Australian assets and few domestic purchases. This is also consistent with the fund survey results of a rise in FX exposure. If 17% really do believe that the AUD is headed higher than its current levels, we may start to see more hedging by the time the next survey comes around. Chart 12: Which direction do you see the AUD in two years? Up Down Don't know No change The vast majority believe that active management does not enhance returns which is similar to prior years. 14

15 Market volatility The movement in the AUD has been a key driver of hedging strategies and changes in the latest survey. But as well as the level of the AUD, it is also the change in the market level of volatility in the currency which may also be having an impact on both hedge levels and FX hedging management. While during the survey in 2013 there was a spike in AUD/ USD realised volatility, this was a relatively temporary phenomena. It was also not backed by a rise in broad market volatility equities in particular. During the 2015 survey, and for months prior in FX, we have seen a more sustained rise in currency market volatility (CVIX). This has been recently matched by a rise in bond market and equity market volatility (VIX). This rise in volatility, which has seen the AUD bounce around through its declining trend, creates uncertainty. There is a reason why many models of the AUD value include measures of volatility it is particularly highly negatively correlated with measures of market movement. The reason why the AUD and many other markets are so volatile at present is due to the uncertainty surrounding global growth, financial vulnerability in differing sectors (emerging markets being a key one) and ultimately a lack of clarity about what central banks are going to do. The US Federal Reserve is the main culprit, with sentiment periodically changing between no increases in interest rates, to more than one, and back again. With economic data globally so variable, and with so much uncertainty from the central banks, it s likely that the recent lift in market realised volatility is around to stay. Periods when it drops to record lows, such as mid-2014, are likely to be viewed as the anomaly. Chart 13: Currency and equity volatility have risen VIX, LHS FX Volatility Index (CVIX), RHS , Macrobond 15

16 03 Regulation and counterparties Regulation and risk management have become a huge part of our everyday life, and it s no different for funds. But it was somewhat surprising in the broader market context, to see a modest decline in the use of some risk management techniques and regulatory influences, compared to the last survey. These results were interesting, in that while more respondents said they were utilising counterparty exposure management techniques (66% from 59%), there was a reduction in the percentage who said they were actually using the stated methods. The most favoured management technique was to manage counterparty concentration exposure by credit rating at 56%, but this was down from 87% in Some 44% of funds limited their use of counterparties as an exposure management technique. Although, this is in contrast to those who noted that their counterparties were increasing (1). Admittedly 46% said that their number of counterparties were unchanged. Perhaps these answers suggest that the changes implemented in the big jump in counterparty management techniques that were reflected in the 2013 survey where those using counterparty techniques jumped from 19% to 59% have been made, so there are fewer changes to be implemented now. Chart 14: Are you using counterparty exposure management techniques? No Yes 16

17 Counterparties and tax treatment Approximately 1 of funds said that their number of counterparties had declined; up from 6% in One consideration of the number of counterparties is the tax treatment of foreign exchange losses and the domicile of the counterparty. The Australian Tax Office s Taxation Ruling TR 2014/7 was a key consideration often cited by respondents during the survey. The Ruling sets out when FX hedging gains are considered foreign-sourced and when FX hedging losses reasonably relate to foreign income. For those funds that do undertake significant FX hedging, the Ruling can affect their entitlement to foreign income tax offsets (FITO) as it applies to the calculation of the FITO limit i.e. cap on the amount of foreign tax credits that can be claimed. If a counterparty is considered offshore, then tax credits may not be applied; if domestic then they may. Given the losses accrued from hedging as the AUD has declined, this is possibly a growing critical factor for funds. The Ruling was applied mid-2014 and as such it may not be something we see fully until the next survey. The 2017 survey will be able to provide a more concrete picture as to the counterparty implication of tax treatment changes on FX hedge transactions. Table 6: Are you using these counterparty exposure management techniques? Regulatory change impacts Regulatory changes had a larger impact on counterparty selection in the 2015 survey compared with 2013, however the levels remain relatively low 21% of funds, compared with 18% last survey, noted that this was the case. Far fewer than counterparty selection (but still an increase on last time) said that regulatory changes were having an impact on the tenor of hedges (yes: 7% from 4%). There were slightly more who saw tools for hedging had changed from regulatory changes (6% from 8%). Use of products It may also be that the rise in regulation, and the regulatory cost of capital, might be having an impact on the type of FX product used in currency hedging. A rising regulatory reporting burden, combined with the need to assign greater capital against options, may be reasons why their use has declined. The rise in broad market volatility, which makes the use of options more expensive, may also be a factor. The caveat to this may be the change in sample size for this year s survey. While the use of FX forwards remains the product used by all funds, the use of cross currency swaps and FX options in particular, has declined. Cross currency swaps are used by 15% of funds, down from 2 in Meanwhile, FX options saw a greater decline in use, from 27% to just 7% of respondents. Using collateral management agreements (CSA) Using centralised clearing CLS or clearing brokers % 63% 58% 37% - 47% 61% 27% Chart 15: The use of FX products Managing counterparty concentration exposure by their credit rating Limiting your number of counterparties % 56% % 44% No answer FX forwards Cross currency swaps FX options 17

18 Contact Us To find out more about the 2015 NAB Superannuation FX Survey, please contact: Emma Lawson Director, Currency, NAB emma.lawson@nab.com.au Disclaimer: This document has been prepared by National Australia Bank Limited ABN AFSL ( NAB ). Any advice contained in this document has been prepared without taking into account your objectives, financial situation or needs. Before acting on any advice in this document, NAB recommends that you consider whether the advice is appropriate for your circumstances. NAB recommends that you obtain and consider the relevant Product Disclosure Statement or other disclosure document, before making any decision about a product including whether to acquire or to continue to hold it. Products are issued by NAB unless otherwise specified. So far as laws and regulatory requirements permit, NAB, its related companies, associated entities and any officer, employee, agent, adviser or contractor thereof (the NAB Group ) does not warrant or represent that the information, recommendations, opinions or conclusions contained in this document ( Information ) is accurate, reliable, complete or current. The Information is indicative and prepared for information purposes only and does not purport to contain all matters relevant to any particular investment or financial instrument. The Information is not intended to be relied upon and in all cases anyone proposing to use the Information should independently verify and check its accuracy, completeness, reliability and suitability obtain appropriate professional advice. The Information is not intended to create any legal or fiduciary relationship and nothing contained in this document will be considered an invitation to engage in business, a recommendation, guidance, invitation, inducement, proposal, advice or solicitation to provide investment, financial or banking services or an invitation to engage in business or invest, buy, sell or deal in any securities or other financial instruments. The Information is subject to change without notice, but the NAB Group shall not be under any duty to update or correct it. All statements as to future matters are not guaranteed to be accurate and any statements as to past performance do not represent future performance. The NAB Group takes various positions and/or roles in relation to financial products and services, and (subject to NAB policies) may hold a position or act as a price-maker in the financial instruments of any company or issuer discussed within this document, or act and receive fees as an underwriter, placement agent, adviser, broker or lender to such company or issuer. The NAB Group may transact, for its own account or for the account of any client(s), the securities of or other financial instruments relating to any company or issuer described in the Information, including in a manner that is inconsistent with or contrary to the Information. Subject to any terms implied by law and which cannot be excluded, the NAB Group shall not be liable for any errors, omissions, defects or misrepresentations in the Information (including by reasons of negligence, negligent misstatement or otherwise) or for any loss or damage (whether direct or indirect) suffered by persons who use or rely on the Information. If any law prohibits the exclusion of such liability, the NAB Group limits its liability to the re-supply of the Information, provided that such limitation is permitted by law and is fair and reasonable. This document is intended for clients of the NAB Group only and may not be reproduced or distributed without the consent of NAB. The Information is governed by, and is to be construed in accordance with, the laws in force in the State of Victoria, Australia. This information is current as at 10 November National Australia Bank Limited ABN AFSL and Australian Credit Licence (NAB) A