As the National Pension's strategic currency hedging begins, some voices are expressing concern over declining revenue. During periods of sharp increases in the won-dollar exchange rate, it has been argued that holding dollars could increase exchange gains rather than selling dollars at a fixed rate under the currency hedging method. However, foreign exchange authorities rebut that with the exchange rate at a historical high, the likelihood of a decline in the exchange rate has increased, thus making it an appropriate time to engage in currency hedging.
Currency hedging refers to transactions that eliminate the risks of exchange rate fluctuations. The National Pension engages in currency hedging by selling some of its foreign assets through forward contracts when the exchange rate level is higher than its self-determined standard (contracting to sell dollars at a pre-set exchange rate at a future point). By selling dollars and increasing the supply of dollars in the market, it has the effect of lowering the exchange rate.
◇ National Pension lowered currency hedging to 0% since 2018… 'Effect of reducing volatility'
According to the National Pension Fund Management Headquarters on the 8th, until 2016, the National Pension maintained a strategic currency hedging ratio of 0% for overseas stocks and 100% for overseas bonds, but beginning the following year, gradually reduced the hedging ratio for overseas bonds, changing the policy to not hedge overseas assets by 2018. Although it was allowed to conduct tactical hedging within 5% of its assets by regulation, it was not actively implemented.
The National Pension's reduction of the currency hedging ratio is due to the increasing scale of overseas investment assets. As of the end of the third quarter of last year, the National Pension's investment in overseas stocks and bonds amounted to 399 trillion won and 81 trillion won, respectively. In terms of investment share compared to total assets, they account for 34.8% and 7.1%, respectively. Given the large scale of overseas investment assets, the costs involved in currency hedging are substantial, and it is also not easy to find places to accommodate the volume.
On the other hand, the practical benefits expected from currency hedging have not been substantial. According to an analysis by the National Pension Fund Management Committee in 2015, when the proportion of overseas investments is below 49%, engaging in currency open (exposing assets to exchange rate volatility in the foreign exchange market without hedging) actually appeared to reduce the overall portfolio volatility of the fund. In terms of long-term expected revenue, there was not much difference between currency hedging and currency open.
However, since the won-dollar exchange rate sharply increased in December 2022, the National Pension's currency hedging policy has been somewhat modified. It has been decided to engage in currency hedging temporarily for up to 10% of overseas assets. The influence of foreign exchange authorities aiming to increase the supply of dollars in the market through the National Pension's forward sales has played a significant role. As this measure continues to be extended, the hedging ratio is still maintained at 10%. Considering that the National Pension's overseas investment assets were at $48.28 billion as of the end of October last year, the scale of currency hedging amounts to $4.82 billion.
Some voices of concern have emerged regarding the strategic currency hedging launched by the National Pension. This is because, while there may not be significant practical benefits in terms of asset volatility or revenue, it could lead to an increase in hedging costs. An industry official noted, 'When looking at long-term studies, the majority agree that engaging in currency open is more appropriate in terms of revenue,' adding that 'not only the National Pension but also most other pension funds have chosen to adopt the currency open method, so even in 2022, when the hedging ratio was raised to 10%, there were voices of criticism.'
◇ Lee Chang-yong: 'National Pension revenue is unrealized... It should be realized when the exchange rate rises.'
However, foreign exchange authorities assert that in situations where additional rises in the exchange rate like now are unlikely, it is advisable to engage in currency hedging. Lee Chang-yong, Governor of the Bank of Korea, responded to a question during a press conference held right after the Monetary Policy Committee on the 16th of last month, stating that 'there is criticism that the strategic currency hedging of the National Pension is based on the collateral of its revenue,' and he countered that 'currency hedging is advantageous for long-term investors like the National Pension.'
The governor stated, 'The revenue of the National Pension is an unrealized revenue whose outcome cannot be known as the exchange rate fluctuates,' adding, 'It is beneficial for maximizing the revenue of each institution to realize a portion of the unrealized revenue through hedging when the exchange rate is abnormally high.' He further criticized that 'talking about losses incurred because the exchange rate rose after hedging means not understanding the meaning of hedging.'
Some experts are also arguing that engaging in currency hedging is preferable given the current significantly high exchange rate. Jeong Yong-sik, a senior researcher at the Korea Institute for International Economic Policy, stated, 'In the medium to long term, it is much more likely that the won-dollar exchange rate will be lower than it is now,' noting, 'The possibility of losses occurring through currency hedging appears to be low at present.' Hwang Se-woon, a researcher at the Capital Market Institute, also commented, 'Opposing currency hedging in a situation where it is uncertain whether the exchange rate will rise or fall is not a reasonable criticism.'
The National Pension is deliberating on appropriate response directions. On the 3rd of last month, prior to the activation of strategic currency hedging, the Ministry of Health and Welfare and the National Pension Fund Management Headquarters held a 'currency hedging expert conference' to explore currency hedging response strategies. At this meeting, senior officials of the Fund Management Headquarters reportedly expressed their intention to maintain strategic ambiguity regarding strategic currency hedging.
A Bank of Korea official stated, 'Currency hedging has the effect of mitigating exchange rate volatility in the process of fixing unrealized gains and converting them into realized gains,' adding, 'It will also contribute to maintaining the overall revenue stably.'