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Hedge demand soars as funds seek to tame volatility

Cecile Gutscher

Monday, September 02, 2013

Investors are piling into funds hedging against currency risk at a record pace on speculation that the Federal Reserve dialing back four years of stimulus will exacerbate foreign-exchange swings.

Money invested in North American- based exchange-traded funds with currency hedges more than tripled this year, while those offering no protection grew 6 percent, data compiled by Bloomberg show.

Franklin Templeton Investments hedged against swings between the US and Canadian dollars in a global bond fund it started offering last month, while Vanguard Group started a fund in May that guards against currency risk of emerging-market bonds.

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Im trying to prepare for the possibility of more volatility at a time when there is a meaningful conversation about when the Fed will reduce its quantitative- easing program, said Jonathan Lemco, a senior sovereign-debt analyst at Vanguard. Vanguard is the world's biggest mutual-fund manager, overseeing more than US$473 billion (HK$3.69 trillion) of fixed-income assets.

The prospect of the Fed reducing as soon as September the US$85 billion it spends every month buying bonds helped push JPMorgan Chase's Global FX Volatility Index to a seven- week high on August 28.

Currency gyrations threaten the returns of funds seeking to profit from carry trades, which depend on stable exchange rates between countries.

Currency-hedged ETFs attracted US$22 billion in net flows this year, bringing their total assets under management to US$32.5 billion, according to data compiled by Bloomberg on more than 100 funds.

Investors use hedges to mitigate the effect of currency swings on items such as interest and dividends.

Typical agreements include forward contracts, which lock in foreign- exchange rates at some point in the future, and options, which give investors the right to make certain trades at later date.

Franklin Templeton is using forward contracts to add protections for Canadians in a hedged version of the Templeton Global Bond Fund, its US$70 billion flagship fund, according to an August 28 statement from the firms Toronto-based unit.

The San Mateo, California-based global fund managed by Michael Hasenstab lost US$611 million in June after attracting more than US$5.6 billion in the first five months of the year, according to data provider Morningstar.

JPMorgan's volatility index rose as the Obama administration weighed military action against the Syrian government for what officials said was a chemical-weapons attack.

"With Fed tapering, geopolitical risk and potential issues in Syria and concern about whether this will be a prolonged conflict, were in for another bout of volatility," said Mirko Mikelic, a senior money manager at Fifth Third Asset Management in Grand Rapids, Michigan.

Mikelic said he favors the US dollar over its Australian and Canadian counterparts.

Price swings are squeezing potential profits for carry traders borrowing in nations with low interest rates and using proceeds to buy in higher-yielding countries.

Deutsche Bank's G-10 FX Carry Basket fell this week to 109.98, the lowest level since June 2012, from a five-year high of 125.44 in April.

The prospect of the Fed reducing its bond purchases and rising tensions in the Middle East are also boosting the have appeal of US assets, including the dollar.

America's currency has gained 1.5 percent in the past three weeks, the biggest advance in more than a month, according to the Bloomberg US Dollar Index, which tracks the greenback against 10 major peers. The gauge reached 1,035.98 last week, the highest level since July 19.

The dollar is the second-best performer this year among 10 major currencies tracked by Bloomberg Correlation-Weighted Indexes, strengthening about 5.9 percent against the basket of peers including the British pound and Japanese yen compared with the euros gain of 6.1 percent.

BLOOMBERG


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