Weaker US dollar hits pension funds harder than falling stock prices

Although Dutch pension funds invest a large proportion of their managed assets in currencies other than the euro, their liabilities are denominated in euro, since pension benefits are paid out in euro.

As the US dollar and several other currencies depreciated against the euro in the first quarter of 2025, the value of these investments decreased in euro terms. 

This foreign exchange effect was strongest for the US dollar: losses due to exchange rate movements amounted to €24 billion (-4%). For other currencies, FX risk losses amounted to €3 billion (-1%).  On top of that, there were also losses due to falling stock prices of €11 billion on all investments in foreign currencies (-1.3%) and of €16 billion on investments in euro (-1.7%).

After the first quarter the US dollar continued to fall, which resulted in a decrease by another -4.9% at the end of May, a foreign exchange effect of about € -27 billion, while stock prices actually recovered. The leading S&P index, for example, rose by 5.3%. Bond prices fell. The estimated price gain on US dollar investments was around €14 billion. 

Pension funds hedge their foreign exchange risk through derivatives

Pension funds use derivatives to hedge part of their foreign exchange risk. Derivatives are financial products that, in this case, move in the opposite direction to exchange rates. For example, if the dollar depreciates, the value of these derivatives rises, partially offsetting foreign exchange losses. 

In the first quarter of 2025, pension funds made a gain of €11 billion on these derivatives, offsetting some 40% of their foreign exchange losses.

However, pension funds do not typically hedge their entire foreign exchange risk, for instance due to the costs associated with derivatives – 
they must be backed by blocked accounts as collateral, which means the money on these accounts cannot be invested.

Pension funds mainly hedge their foreign exchange risk on fixed-income securities, such as bonds. They do not hedge their equity investments, or only to a limited degree, because the trend in stock prices is often opposite to that of the US dollar: when stock prices rise, the US dollar depreciates, and vice versa. This opposite correlation further limits the overall risk that pension funds face with respect to their foreign exchange investments. Over the last five years, some 50% of the foreign exchange risk has been offset in this way.  

Moreover, stock prices and the US dollar often move in opposite directions: when stock prices rise, the US dollar depreciates, and vice versa. This opposite correlation further limits the overall risk that pension funds face with respect to their foreign exchange investments. Over the last five years, some 40% of the foreign exchange risk has been offset in this way.

This effect occurs because stock prices and the US dollar exchange rate generally react in opposite ways to a change in interest rates. When interest rates rise, capital often flows into the United States (to buy government bonds), causing the US dollar to appreciate, and vice versa. The effect for prices of these bonds, and also equities, is exactly opposite: higher interest rates cause them to fall.

This correlation makes it all the more remarkable that both stock prices and the US dollar fell in the first quarter of 2025. This was partly linked to uncertainties surrounding the policies of the new US administration.