These days, billions of dollars, euros, renminbi and myriad other currencies are travelling across borders to be invested in real estate. As such, the need for international property investors to consider currency risk has arguably never been greater – especially in a time when foreign exchange (FOREX) markets are so stormy.
“We are seeing volatility almost back to financial crisis levels. It is that extreme at the moment,” says Matthew Clarke, head currency consultant at Global Reach Partners, a London-based foreign exchange specialist.
This year already, Australia’s and New Zealand’s dollars, for instance, have lost more than 4 percent each against their American counterpart, while South Africa’s rand has lost 8 percent as of press time.
Such volatility is taking its toll. In one example of its impact, PERE understands that the Australian property deals of one well known international private equity manager are underwater due to the country’s currency devaluation. The transactions were expected to foreshadow an Asia-Pacific fundraise for the firm, but their current performance has caused a halt on any fundraising activity and now it is having to defend itself from criticism from would-be investors for not mitigating the currency risk.
Of course, not all volatility is bad for investors. As with other aspects of investing, much depends on timing. “Demand, particularly from offshore investors, for high-quality Australian real estate is now insatiable. The fall in the Australian dollar has only served to make it more attractive,” according to Carmel Hourigan, global head of property at Sydney-based fund manager AMP Capital.
Devalued currencies are only attractive to those with greater buying power as a consequence. As it stands, US dollar investors have been given more bang for their buck in international markets due to the US’ rapidly strengthening currency against other denominations and that is influencing strategies at certain firms.
Says Simon Martin, head of research and strategy at Tristan Capital Partners: “We do see a lot of people from the US coming into Europe because they see the euro as cheap.” For groups like Tristan, the net effect of a US dollar bull market has been positive, particularly for fundraising. The London-based real estate investment manager hit the €1.5 billion hard cap for European Property Investors Special Opportunities 4 (EPISO 4), its European value-added and opportunistic fund, in only four months and Martin puts some of this success down to an influx of US capital. “We have been able to assemble capital quicker and so get into the market and invest quicker. If you buy the idea that capital flow today creates asset price appreciation 12 months to 18 months forward, then the quicker we can get deployed in a disciplined fashion the better.”
And yet not everyone agrees that currency has such a big impact on the flow of capital. Lee Menifee, head of Americas research at Prudential Real Estate Investors (PREI) questions currency as a motivation for the biggest institutions. “The largest investors also invest in currency and other asset classes and get exposure in other ways so I think often those decisions are made independently.”
“There may be a difference among smaller institutions who have almost all domestic exposure, which may be more of a factor.”
An example of this was seen shortly after the Swiss Franc dramatically appreciated last year, says José Luis Pellicer, partner at Rockspring Property Investment Managers. “Such a sudden and massive FX change caused non-Swiss investors to shy away from the market. On the other side, Swiss investors thought investing into the Eurozone looked cheap.”
Certain sector executives have questioned how cheap the euro actually is, especially against the dollar. One global head of the real estate arm of a US bank suggests that the current dollar-euro split is within a degree of normality, and over the typical seven year lifetime of a real estate fund there is no benefit for US dollar investors.
Feeling the pain
When the US’ globally dominant economy and currency is on a run the impact is keenly-felt in emerging markets. Certainly it has made life more difficult for Chinese investors as it pegs its currency to the US dollar. A strong US dollar causes Chinese products to become less competitive internationally, the Chinese economy slows and consequently the country’s China currency peg slips, and the corollary spreads even further.
That symbiosis is provoking investors to ask: if China is unpegging, what happens to all the emerging market currencies linked to China?
“When the US dollar starts to move up people in emerging markets feel the pain,” explains Martin. “A lot of people in those markets also borrow in US dollars, so as the peg goes up the value of their debt increases but their revenue doesn’t change.”
And so foreign fund managers making investments in the US face repatriation concerns at the realization stage of a holding period.
“There is an obvious risk to fund managers that possess large investments in the US, which is why they need to put into place FX hedging strategies against currency risk to ensure they do not lose out when it comes to repatriating funds,” says Global Reach Partners’ Clarke.
While repatriating funds to investors must be well-timed to take advantage of positive currency movement, so too does the timing of the actual investment, Clarke points out. If a UK manager is closing a deal to buy an asset in Europe, for example, it could save significant money by being advised on the precise timing of its spot trade.
“We are seeing 1 percent swings over a day, and we have witnessed as much as 2 percent or 3 percent over the duration of a week. Sterling/euro was at 1.45, but is now down at 1.36,” says Clarke.
Such swings are provoking some real estate fund managers to re-visit their currency risk policies.
Horses for courses
Given the variety of different types and sizes of private real estate managers in the market today there is some divergence when it comes to currency hedging policies.
“Some might say they will hedge up to 50 percent of the initial equity, some will hedge income flows, others hedge 100 percent, and it varies. The more you hedge the more expensive it gets and that is a drag on returns, even if you get your hedges right,” explains Paul Guest, lead strategist, global real estate at UBS Asset Management.
Take Rockspring as an example. Pellicer says his firm will either fully hedge currency or it won’t hedge at all. “Many real estate investors are good at selecting properties but are not in the currency business. It’s our clients who hedge at the higher level and manage their own exposure.”
Other firms have a more flexible system for currency hedging. Marcus Davidson-Wright, the head of debt, fund operations and risk at Paris-based investment manager AEW Europe, sees hedging as a balancing act.
“The amount of equity you hedge can depend on a combination of how expensive it is and tolerance for movements in exchange rates, and if you can avoid hedging because you have a natural hedge in the portfolio then you do so,” says Davidson-Wright, who adds that there are times when hedging is too expensive for a given investment and you may choose to invest where there is no cross-currency exposure if this option is available.
Aviva Investors, the global asset management platform of UK insurer Aviva, will alter its hedging strategy for different vehicle types, strategies, and geographies. David Skinner, global head of strategy and portfolio management at Aviva, says that in some cases Aviva will take the view that it is too hard to hedge or expose the firm to risks it doesn’t want to be taking on so the firm sells mandates on the basis of an unhedged exposure.
“One of the challenges is where we have a multi-jurisdiction fund, such as a dollar denominated fund investing in a bunch of Asia-Pac markets. You have got cost issues on hedging, there may not be an efficient market to access the currency hedging instrument, and you have got a lot of them to do if you are invested in a large number of countries, and that obviously brings with it complexity.
He adds that for global opportunistic strategies it is easier to hedge your euro-dollar exposure, whereas your Chinese exposure is more difficult to hedge. “Then we won’t hedge but we will make sure there is a premium when we are underwriting a transaction for currency volatility in our target return for that investment.”
Kings of the hedge
At the more sophisticated end of the currency mitigation spectrum sits Morgan Stanley Investment Management.
Working across Morgan Stanley’s Merchant Banking & Real Estate Investing businesses is a dedicated hedging department led by managing director Sunil Mody, based in the firm’s New York office. “I oversee a team that is 100 percent dedicated to look after the currency and interest rate exposure across our platform as investments are made,” says Mody.
“My job is to recommend hedging strategies, execute the hedges and monitor their performance. I would say you might find someone like me at the very large private equity real estate firms, but once you get a bit smaller, firms often hire third-party advisers to execute and structure hedges.”
Institutional investors of course value a firm’s efforts when it comes to mitigating risks. But, not all institutional investors want their fund managers taking such an active role in currency hedging and prefer to have that risk managed in-house.
Davidson-Wright says a prior fund he worked on before his time at AEW Europe was completely unhedged for FX movements due to investors using the fund itself as their hedge.
Investors should also be considerate of fund managers’ hedging needs though, argues Russell Platt, co-founder of London-based private equity real estate firm Forum Partners.
He says: “Some investors might say: ‘I have got a very professional currency overlay program, we don’t want you to do that’. We say: ‘fine, but let’s sit down to talk about how we hedge our own promote. Even though you are happy hedging your principal risk, we want to make sure our promote, which is ultimately paid in X, Y or Z currency is protected.”
“While there might be some very strict church and state form to that view of the world, today I don’t think that holds much water. Even if that is the way a client wants to draw a particular mandate, any manager thinking in a holistic way about an investment opportunity has to be thinking about currency, plain and simple.”
Greg Mansell, senior strategist at AXA Investment Managers – Real Assets, says that the big investors, whether pension funds or sovereign wealth funds, are actively encouraged by the insurer-owned platform to take such a dynamic approach.
“They are starting to reconsider their hedging ratios. When new mandates come in it’ll be interesting to see if the starting position changes, will they go for a more dynamic hedge, or something that the investment manager will have to make a decision on.”
Ultimately, there is little consensus on what hedging policy works most effectively for private real estate investment managers, though many agree it is something of a personal matter. But thanks to the sheer volatility seen in the currency markets of late, many agree that hedging calls have forced their way from being a marginal consideration to something altogether more integral.
As the aforementioned global private equity firm with poorly-timed deals in Australia is learning to its detriment, getting your currency calls right does matter.