For any investor who is exposed to currency risk, exchange rates may significantly impact their returns. In order to mitigate this risk, most Investment Management firms offer a program of different hedged share classes with the aim to reduce the effect of movements in exchange rates between the currency of the Hedged Class and the Base Currency of a portfolio.
To ensure that different share classes remain correlated to the base currency of a portfolio, Investment Management firms typically perform ‘Share Class Hedging’ on a daily basis. Whilst asset and portfolio hedging are driven and directed by the investment management process, share class hedging is rules based and designed to insulate the investor from currency risk, if his base currency is not the base currency of the fund. As such it adds no alpha but can be a substantial drain on the performance of the hedged share class, if it is not managed correctly.
As the majority of the output from a hedging program is covered under MIFID11 regulations, a manager needs to be able to discharge their fiduciary responsibility and have full confidence in the underlying hedging program. The effective management of operational risk, full transparency, effective attribution and reporting typically form the basis of best practice.
Notably, investors in funds are increasingly interested in the performance differences created by share class hedging programs and require managers to explain these costs which they expect to be fully reconciled and understood. As shown in figure.1 below, divergence of performance between share classes will become more pronounced over time.
Source: Lumint Capital Management Inc.
In the event that an investment manager wishes to outsource some or all of their hedging program, Lumint and New Change FX (NCFX) have joined forces to provide a new solution which they believe addresses all the major challenges and opportunities faced by the manager.
Lumint Currency Management Inc. provides a full STP process to obtain the necessary hedge data and establishes a clear rules-based hedge calculation process. In addition to this service of performance attribution and analysis, the LUMINT product set offers a variety of bespoke solutions tailored to meet a client’s individual requirements. This enables clients to either outsource their hedging requirements entirely, including an agency execution capability or to provide an effective software application that allows them to manage this activity themselves.
NCFX is an ESMA and FCA Authorised Benchmark Administrator that calculates and publishes the only live FX Benchmarks. This output powers advanced, independent transaction cost analysis (TCA), to enable the transactions costs within a hedging mandate to be fully understood and importantly incorporated into fully reconciled attribution reporting that helps to explain the difference between the hedged and unhedged mandate.
Lumint and NCFX have combined their product sets to facilitate clients to outsource their hedging requirements with full confidence. In doing so, they will gain a complete understanding of the costs associated with this activity and will also understand the benefits of having a well-managed share class hedging solution too.