A hedge provides protection from unwanted effects of whatever it is you don’t want to be negatively affected by. In your garden, a hedge may provide protection from the sun, unwanted visitors, and privacy. The hedge generally acts as a protective mechanism.

For long-term investors such as pension funds, a hedge can provide protection from the eroding effects of devaluation (which has averaged 13 per cent per annum for the last 40 years) and inflation (which has averaged 11 per cent for the past 10 years).

It is easy to quote these percentages, but what does it translate to in dollar terms? To truly put this in perspective, take a look at how the purchasing power of your Jamaican dollar in terms of the US dollar has changed over time. Three thousand Jamaican dollars, which could buy US$1,685 in 1980, could just buy US$461.54 in 1990 and can purchase US$28.36 today.

The effects of inflation also ravage the value of your money. $3,000 in 2000 would have the same purchasing power as $1,156.63 in 2013, using the ten-year inflation rate of 11 per cent. These effects are real and should be considered by investment managers or pension trustees when assessing performance or investment opportunities. These effects, coupled with the write-downs from two successive debt exchanges, have severely decreased the size of their portfolios and the funds available to the existing contributors and future beneficiaries. This is largely due to the high concentration of Jamaican dollar debt instruments in their portfolios.

To protect long-term assets, trustees of managed portfolios such as pension funds or trust assets would be well advised to seek a hedge from these effects. The US dollar can provide a hedge to Jamaican dollar income earners against these effects.

However, how do you get United States dollars in an environment of tight liquidity or if there are restrictions on the level of foreign currency assets that may be held?

A range of new products denominated in Jamaican dollars, but indexed to the United States dollar, have emerged in the local marketplace. This allows long-term investors, particularly pension funds, to preserve and grow the value of their capital over time.

The Bank of Jamaica has so far this year offered some US dollar-indexed notes, which provided portfolios with a hedge but was classified as a Jamaican dollar investment. The response from investors has been overwhelming. A similar hedge is provided by companies that earn the majority of their revenue in US dollars; some companies earn up to 100 per cent of their income in US dollars.

Ordinary shares in these companies can help protect and grow the real value of capital over time. Investors would be well-advised to ensure that the issuing entity and the underlying assets are of sound credit quality.

In the seemingly complex world of finance, banks, pension funds and other financial institutions use hedges to protect them from changes that could negatively affect their portfolio. For example, rising Jamaican dollar interest rates currently pose another threat to the portfolios of these entities. With the six-month Treasury bill yielding 7.8 per cent per annum, banks and pension funds stand to take sizable losses when they mark their fixed income securities to market at these higher rates. Rising interest rates are yet another blow to pension portfolios post-JDX and NDX.

Given the experience of these debt exchanges, pension fund trustees must ensure that their managers are seeking to diversify their holdings and access shorter dated more liquid securities. In the aftermath of JDX and NDX, Investment Managers have sought refuge in some corporate debt and equity issues which are yielding returns BELOW inflation and devaluation.

While diversification is important, the quality and liquidity of the assets as well as their returns determine how effective “diversification” is. It is impractical to reduce credit risk but invest in securities that are losing money in the medium to long term.

Speak with your investment advisor to find out about the latest local Jamaican dollar investment to provide a hedge and real growth in US dollar terms for your pension portfolio.

Marian Ross is AVP — Business Development at Sterling Asset Management. Sterling provides financial advice and instruments in US dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm.