Family offices have grown increasingly concerned about their foreign currency exposure in recent months as they have watched the euro spiral downward and sovereign debt problems surface around the world, writes Michael S Fischer.
"The topic of currency exposure will certainly become more of an issue for family offices over the next 12 to 18 months," says Fred Fruitman, managing director of the New York Loeb family's investment firm, Loeb Partners Corp.
Felix Adam, chief executive of ACT Currency Partner AG in Zurich, agrees. "At the moment, everyone talks about unwinding their euro exposure. Even European family offices think they have insufficient foreign exposure, while the Americans think they have too much euro exposure. Three years ago, it was the other way round."
For Adam, a veteran of the financial business, this is all part of the game. "When equities and bonds are collapsing, people panic. Of course it hurts when equity markets come off, when bond markets crash, and if you hold euros in a situation such as we have today," he explains.
Discussions with family offices and consultants in Europe, North American and Asia turn up a variety of approaches to managing foreign currency exposure.
Fruitman notes that for US-domiciled families, the rule of thumb seems to be that 70% of their assets should be held in US dollars and 30% in non-US dollars. The 30% could be unhedged equity portfolios, property or emerging markets. He says most American families get currency exposure by investing overseas, but not hedging their investments: "The number seems to be a consistent 25-30%."
Families domiciled outside the US face a more complicated situation, says Fruitman. They have to figure out in which currency they pay most of their bills, and that denomination should form the bulk of their currency exposure. He observes, however, that the 70-30% rule seems less applicable in Europe where investors tend to be more diversified than their American counterparts.
"The key is to think about allocation beforehand and have a plan for difficult times," says Adam.
Good advice, but how many family offices follow it? "I'm not sure how seriously many families look at their forex exposure," says Christopher Jackson, president of SFG Advisors, a single family office in San Francisco. "It's on everybody's mind, but actively doing something about it and making a decision is another matter. The thing about making an investment call for many family offices is that there is no upside to the people who work there, because if the dollar goes down in your foreign investment, you don't see that immediately; in fact your equity portfolio may go up."
Jackson says foreign currency management is a fraught issue at family offices. "How much foreign exposure do you have in your portfolio? Defining what that foreign exposure is is fairly complicated because many global US companies could have a lot of foreign exposure, and they may do very well when the dollar goes down."
Problems surface when a family office actively allocates outside the dollar and the dollar strengthens as it has this year, says Jackson. "That looks pretty bad. You see the negative impact of a strong dollar when you allocate outside immediately, and you have to answer for that. There's an incentive to sit on one's hands rather than recognise that it is an investment and it does create risk and that you have to have an opinion on that."
What about currency funds to manage exposure risk? "The best currency managers have proved that a combination of fundamental process together with some more quantitative overlay can actually produce good returns over time," says Chris Turner, head of strategy at Lombard Street Research in London. "But it's probably a situation where the number of people doing it well is fairly small."
Loeb Partners' Fruitman rejects currency funds out of hand. "Currency should be something you try not to speculate in because nobody really knows where currencies are heading. People come to me saying they have a currency fund and promising this, that and other, but I say 'that's just gambling and I don't want anything to do with it'. You have to look at your currency strategy from the point of view of diversification, capital preservation and risk aversion, not 'how can I make money from currency'."
Michael S Fischer has written a longer version of this article that will feature in the forthcoming issue of Campden FO magazine.