Pension fund clients have unique challenges in ensuring they are engaging the FX markets in the most effective ways to minimize their costs.
As a first step, many funds want to ensure they are not having their FX trades lumped into an inefficient and costly process for pricing that does not take advantage of tools for sourcing liquidity from multiple liquidity providers.
Brad Bailey, Celent
A key challenge is often the custodial relations and the choices pension fund clients have in ensuring flexibility for their FX needs, says Brad Bailey, research director in the securities and investments group at Celent.
He adds it has been clear during the past few years that pension funds have paid too much for their FX transactions whether in spot or other products.
Amarjit Sahota, director at Klarity FX, agrees that how the fund has negotiated its contract with its custodian is vital, adding: “Although FX volumes through custodians has been reduced along with the spread/fee models they deploy, there remains a significant underperformance compared to the available FX pricing from other counterparties.”
Mike DuCharme, head of currency strategy for the investment services group at Russell Investments, refers to three aspects of successful FX programmes: transaction cost monitoring; centralized trading to take advantage of netting amongst individual managers; and high-quality executions.
“By high quality we generally mean low cost,” he says. “Other components of high quality include trading restricted currencies, monitoring real-time execution costs and evaluating counterparty trading effectiveness.
“Most pension funds delegate currency trading to their investment managers, but we do see a few funds managing currency in-house.”
Most pension funds employ an internal or external transaction cost analysis (TCA) product to help monitor their transactions, observes David Ullrich, senior vice-president, execution strategies at FlexTrade.
“Both asset managers and pension funds are beginning to employ multi-asset execution management systems that encompass all asset classes under one umbrella,” he says.
Pension funds that are most actively managing their FX processes, market engagement and trading costs are utilizing EMSs. In most cases, they are looking for multi-asset EMSs so they can leverage similar technology, processes, market engagement and algorithmic models from equity in their FX trading.
For the group of pension funds that have in-house currency desks, the choice of EMS can make a big difference when it comes to reducing their transaction costs, says Vikas Srivastava, managing director, business development at Integral Development Corp.
“An effective system will offer advanced execution strategies with multi-bank liquidity and advanced netting that can optimize across currency pairs,” he adds.
A pension fund can work with its managers to net trades at specified times of the day, before executing in the market, says Srivastava, adding: “Pension funds can also coordinate with their peers to increase netting opportunities across the board.”
Celent’s Bailey observes there are more diverse technology solutions available to allow pension funds to determine whether they want to utilize better direct engagement with the FX markets to manage that process or to add a more robust internal FX infrastructure.
“As many of the liquidity pools and technology tools are consolidated, major vendors are providing holistic tools for pension fund managers to access better pricing, liquidity and analysis of their trading,” he says.
Some large pension funds get involved in trading FX and some do a good job of it, notes Andy Woolmer, CEO of New Change FX.
“These funds understand and measure every cost element in the execution process,” he says. “Of course, some are less diligent in the monitoring processes and we often see asset owners using bank algos and then accepting bank TCA to measure those algos.
“This is circular referencing that hides deficiencies in the execution choice.”
Brian Ward, director of benchmarking and monitoring at Thomas Murray, says funds are showing more interest in monitoring the efficiency of FX trading, but that the effort and benefit of monitoring every individual trade might be questionable.
“After all, is the purpose to ensure that the service provider always achieves better than the benchmark?” he concludes. “In reality, there will be some trades executed better, worse and on the money.
“Perhaps a more effective way to monitor execution and cost is to look over a longer agreed period where the ups and downs can be smoothed. In our, a minimum period should be 12 months for such an exercise.”