Private Wealth and the Increasing Importance of Share Class Hedging for Private Fund Managers

Overview

Having different currency share classes within a fund has been a longstanding practice for several fund managers as they have looked to open-up access to their products to broader audiences. However, this has taken on increased importance over recent years as managers have looked to raise capital from private wealth investors. While larger institutional investors may have the processes and infrastructure in place to deal with investments in different underlying currencies and FX risk exposure that this may bring to their portfolios, most individual investors will not.

As such, it is increasingly incumbent on the fund managers themselves to offer hedged share classes for investors in order to facilitate fundraising from this segment.

Why Hedge?

Offering a hedged currency sleeve that helps to mitigate any FX volatility can broaden the appeal of funds to investors who may want to invest in their local currency. FX hedging is particularly relevant for strategies that generate relatively predictable cash flows, such as private credit or real assets, where FX volatility could have a material impact on the returns of investors.

Key considerations

Liquidity

FX Hedging will have cash flow impacts on the fund. FX forwards, particularly those that are longer dated, may require the fund to post collateral while the position is open. Even in cases where the fund isn’t required to post collateral, some liquidity will be required to settle the hedge each time it is rolled.
These cash flows may create liquidity issues for funds that are investing in largely illiquid assets and could also have a drag on the performance of the fund if not managed appropriately.

Therefore is important when creating a hedging program that fund managers take into account the potential cash requirements of a hedging program and the liquidity profile of the underlying fund.

Costs

FX hedging brings additional costs, many of which are often not apparent to fund managers. There may be transaction costs and credit costs associated with the use of FX forwards that managers should monitor closely in order to ensure these are not having a meaningful impact on returns.

Operational Burden

Establishing and maintaining an effective FX hedging program can be a complex and time consuming process for fund managers:

• Designing a hedging structure aligned with the needs on the underlying fund
• Onboarding new FX counterparties, involving KYC, AML, ISDA, and CSA negotiations
• Ongoing counterparty management
• Executing FX trades and ensuring a robust process around this

Furthermore, the manager may have to take on the operational risk of running the program internally. Meaning that the manager would be liable for any human errors made throughout the process (e.g. missed trades).

How Record can help?

Record provides fund managers with fully outsourced bespoke FX risk management solutions. Record takes full responsibility for the design, set-up and ongoing maintenance of hedging programs.

Record helps fund managers to maximise the efficiency of their hedging programs, while taking on the operational risk and burden.

To learn more about how Record works with fund managers, please reach out to [email protected].

Disclaimers

This material has been prepared for professional investors.

Accordingly, certain assumptions around your knowledge of market practices, derivative instruments, and associated risks are assumed as understood. When providing advice or making discretionary investment decisions, based on information provided by you, we shall be responsible for assessing the suitability of investments as required by FCA, SEC and CFTC rules as applicable. You shall be responsible for ensuring that information provided to us is kept accurate, complete and up to date so as to enable us to assess the ongoing suitability for you.

The views about the methodology, investment strategy and its benefits are those held by Record Currency Management Limited at the time of presentation.

There is no guarantee that any strategy or technique will lead to superior performance. The use of derivatives means there is credit risk associated. The nature of hedging with derivatives means that there will be intermittent cash flows, which can be large monetary amounts both positive and negative.

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