Recent experience has shown that cost, risk and fee levels are highly variable across the market with variation in the out-turn of Hedging costs being more than 25% of 2010 returns. In addition, large-scale cash calls resulting from hedging have a disproportionate impact on cash mechanics, which can be both problematic and expensive.
IGS's FX service can examine the issues that arise when deploying a Share Class hedging strategy and will cover the areas of risk and cost together with a view on best practice in the absence of Industry-preferred standards. With a greater focus on Operational Due Diligence by ever more demanding clients and suppressed return levels causing unrelenting focus on all costs and return maximisation, a thorough understanding of the costs, risks and best practices is required for the formerly mundane area of Share Class Currency Hedging.
How we work
Having identified the many issues and pit-falls associated with Share Class Currency Hedging we can offer up to date and relevant advice on how to optimise your Share Class Hedging Programme, and make it future proof and able to adapt to market conditions. Our service focuses on five key areas;
1. NAV Accuracy
The regime under which the NAV-estimate is calculated is dictated by the level of granularity available within the portfolio, which is a particular problem with Fund of Hedge Funds. The timeline from the last accurate, hard NAV to the calculation of the month-end currency hedges can be as much as 30 days.
IGS FX works with its clients to establish an efficiently optimal process with the assistance of the Fund Administrators and Managers through the use of a data/risk aggregator that can provide for very short time-lines between the source market information and the hedge date.
2. Cost Reduction
Given the widespread practice of devolving Currency Hedging to the Administrator/Custodian Bank, there is strong evidence that many Fund managers have little information on the actual costs incurred in the FX Hedging Process, the total level of fees/brokerage and the relative efficiency achieved for them.
Analysis of the costs incurred by Funds using their prime broker versus Funds using a specialist provider show that, on average, a saving of between 3 and 5bps per month is achieved. This equates to a saving of up to 60bps annually, which is easily in the realm of ‘significant.’
3. Dynamic Hedging
Assuming that the delivery of NAV data has been affected so as to minimize black-out periods and to achieve highly accurate soft-NAV’s, a process of dynamic hedging should be agreed with your broker whereby a maximum drift level is agreed (usually between 2.5% and 5%). Should the Intra-month FX hedging requirement drift outside of these limits the hedge would be altered to re-fit.
IGS FX has extensive experience in developing systems and protocols to allow Share Class Hedging to become a fluid process rather than the digital system that most Funds employ.
4. Use of Options
The use of options in share class hedging has increased slightly but is still seen as introducing additional secondary and tertiary risks which can become problematic in times of volatility spikes. Further, the use of options is generally more appropriate for longer hedging periods than monthly rolling hedges.
5. Liquidity Management
In order to avoid the risk of large Cash Collateral calls, the use of multi-Tenor forwards enables the Fund or Fund of Funds to better manage the Cash Mechanics of the FX Hedging.
With IGS FXs assistance, it is possible to optimize this process to fit the specific nature of the Fund and its information flow.