FTSE Group has launched a reference index based on a diversified basket of currencies and commodities that aims to protect investors from currency and inflation risks and safeguard real wealth.
The FTSE Wealth Preservation Unit (WPU) can be used as a systematic hedging tool by institutions via overlays, swaps or ETFs, for example, or investors can buy the components of WPU in a portfolio with FTSE’s chosen weightings.
The unit has three components: developed market currencies to diversify foreign currency exposure; emerging market currencies to hedge against external devaluation risk; and gold and oil, to hedge inflation risk.
The base date of the FTSE hedging unit is December 31, 2011, while its base value against the US dollar is one. The price of the WPU is published daily.
Peter Gunthorp, FTSE’s director of research analytics, notes that the index provider chooses the weightings of these developed market components to minimise volatility versus the US dollar. The weights of its EM currencies are GDP-based.
“What we expect to happen is that bank trading desks will create baskets of WPU for investors to hedge into,” he says.
Over the longer term, he hopes demand will pick up for a forward rate, allowing investors to hedge currency risk separately into a WPU forward contract.
FTSE will rebalance the index components and weightings each November, while the weightings change throughout the year as the relative price of the currencies and commodities move.
Gunthorp notes that while there are similar products available, none of them are done in a systematic way. “They are either just based on GDP weight, or there is no attempt to preserve real wealth or to diversify risk,” he says.
He argues that such a tool is increasingly relevant in today’s world where central banks are printing money, Europe is bailing out member countries and the US dollar is hardly supported by strong economic fundamentals with regards to its public debt levels.
“You would probably have more concerns today about the future prospects of developed market currencies than you would have done for a long time,” says Gunthorp. “That makes WPU more relevant than it might have been historically.”
He acknowledges that some institutional investors carry out their own hedges, but points out that hedging back to a single currency is risky.
“What WPU allows you to do is to hedge into something less risky, more diversified and potentially cheaper,” adds Gunthorp. “Another angle is that some fund sizes are so large relative to the local currency market that you couldn’t actually put a hedge in place, whereas WPU has got liquidity.”
He adds that by hedging into WPU, investors could also opt to increase overseas exposure away from their domestic market. “There is a benefit in terms of international diversification,” he suggests.
Potential markets for WPU in Asia are those with significant assets denominated in foreign currencies including Japan, China, Taiwan, Korea and Malaysia.
FTSE designed the WPU in conjunction with Seattle-based currency firm Mountain Pacific Group, which approached them over a year ago with the idea.
The index provider breaks the world into three regions: Asia, the US and Emea. It has around $3 trillion of assets under management linked to its indices globally. It has various index partnerships with Asian stock exchanges, and also runs the FTSE China Index Series.