Rabo Olsen -
HEDGING CURRENCY
RISKS
14
info exchange
What's NewS Issue 10 November 1997
Our many internationally-active clients are acutely aware of the
fact that attractive investments abroad also, necessarily, entail
unwanted currency risks. What's NewS visits a new Utrecht-based
venture, Rabo Olsen Global Overlay Strategies, to find out how
these risks can be mitigated.
Rabo Olsen is a recently-inaugurated joint
venture with the Swiss-based Olsen
Associates, a leading developer of
advanced software technologies for
analysis of the behaviour of international
financial markets. The venture is dedicated
to helping its clients manage their foreign
exchange (FX) exposures by applying a
scientifically-formulated dynamic hedging
service. Such management of FX exposure
via outsourcing to a third party is called
currency overlay. 'The aim is to spot
market trends and to react in such a way
as to maintain or enhance a customers'
investment return,' explains Flaijo
Dijkstra, who has assumed a new role as
Rabo Olsen's managing director.
ADDRESSING VOLATILITY
Big Dutch players in the investment
community - for example pension funds,
insurance companies, and mutual funds -
have roughly a thousand billion guilders
in assets under management. Of this sum,
at least a quarter is invested outside the
Netherlands. Since their liabilities are
Richard Olsen of Swiss-based Olsen
Associates, our partner in the
recently inaugurated joint venture -
Rabo Olsen.
denominated in guilders and the proceeds
collected in other currencies like dollars,
DM and Yen, the importance of hedging is
quite clear, particularly in periods of
pronounced volatility. For US investors in
US stock indices, to cite one example,
foreign exchange fluctuations can increase
the volatility of returns by an average of
33 per cent.
ONE-OFF HEDGING
Investment firms traditionally focus on
choosing an optimized portfolio of stocks,
bonds, and real estate in which to invest,
and they tend to outsource the hedging
function, which is to say the managing of
the currency risk, to some specialized
outside supplier like Rabo Olsen. They
also tended to manage currency risk using
a so-called 'static' approach - for example
through a single, one-off hedging
operation. But increasingly, they must
respond to a more volatile market as well
as to demands by their shareholders that
they specify in great detail where their
investment returns are coming from.
FREQUENTLY ASKED QUESTIONS
Did the given fund perform well because
the dollar advanced against the guilder?
Or because of some underlying increase in
the value of the investment portfolio?
These and other questions are being asked
with greater frequency, leading to greater
attention being paid to currency risk, and
a compression of the time horizon within
which it is managed. These overall market
trends work to Rabo Olsen's advantage
because its currency overlay strategy
replaces the traditional static hedge, which
carries definite opportunity costs for the
investor, with a more dynamic response
that continuously aligns the level of the
hedge to actual FX market conditions.
LEVEL ADJUSTMENTS
By shifting the extent of hedging, Rabo
The team dedicated to helping clients manage
their foreign exchange from left to right:
Bas Dijkman, Dian Das, Haijo Dijkstra,
Guus de Rooij, Marcel Vernooij, Stefan Boe*W
(not present Michael Zoet and Rachel Bosman)
Olsen can help the cliënt not only reduce
risk, but actually increase performance at
times when exchange rates move in the
investors' favour. 'If the dollar goes up
against the guilder, why hedge it as fully as
when it is going down?' asks Dijkstra. 'By
adjusting the level of the hedge to actual
market conditions, you can save your
customer money via lower hedging costs
at the end of the day.' Rabo Olsen builds
this value-adding service by making use of
a unique database that contains
accumulated information on all high-
frequency trades going back more than a
decade. This information, combined with
advanced software models developed after
intensive research into actual FX market
behaviour, has produced sophisticated
hedging capabilities. 'Daily, there are
around 15,000 currency trades stored in
our database,' remarks Marcel Vernooy,
another Rabo Olsen director. 'No other
competitor can base their analysis on such
a complete picture of market behaviour.'
IDENTIFYING PATTERNS
The database reveals exploitable variations
from the 'efficiënt market' theory. The
diversity of the markets' participants, all of
whom respond differently and with
varying time horizons to the same
developments, together with a statistically-
demonstrable market 'memory' which
influences actual developments, make it
possible to identify certain patterns in the
way currencies tend to move in the short
term. 'By spotting and acting upon short-^J|
term trends in the FX market, we can
reduce the clients costs,' Dijkstra explains.
The Rabo Olsen currency overlay strategy
can be customized to specific portfolio
