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Capital Markets

Research: State Street warns against currency complacency

The search for yield has resulted in an increase in overseas investment. But according to a recent research note put out by State Street Global Advisors, fund managers might have been lulled into a false sense of security by the low volatility environment.

Citing data from the WM Company, State Street Global Advisors says the average UK pension fund has increased its exposure to international equities from 21.8% at the end of 1996 to 31% in December 2006. The implication is that currency management has assumed even greater importance.

However, Collin Crownover, head of currency management at State Street Global Advisors, is not sure that all fund managers realize this. "In today’s low volatility macroeconomic environment, many investors have been lulled into a false sense of security in their international investments, unaware that volatility in currency markets has decreased considerably less than in equity and bond markets," he says. "Pension funds need to ensure that they manage their downside currency risk effectively, or risk being caught out when markets move adversely."

Overexposure

State Street Global Advisors also sounds a warning about overexposure to carry trades. "Pension fund exposure to carry trades is at an all-time high. If investors start to unwind their carry positions, as many have predicted could happen, those schemes that have not hedged effectively against currency movements could experience a significant decline in the value of their assets," says Crownover.

The FX market has never been as transparent and as accessible.

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