We’ve now reached the mid-way stage in our series of blogs about currency hedging. It therefore seems appropriate to pause for breath and remind ourselves what we’ve already covered to date.
15 Mar 2019
In our first blog, we looked at how you can hedge your foreign currency exposure. In particular, we looked at the use of forward contracts to mitigate the exposure. These are agreements under which you agree to buy a fixed amount of foreign currency on a specific date in the future for a fixed amount in your local currency. Specifically, we looked at how the forward rate is calculated, the importance of hedging out your currency liability and the difference between a spot rate and a forward rate, using examples to illustrate it.
In blog number two, we looked at forward exchange rates and their impact on returns. This blog explained how you can calculate the yield of a forward exchange contract. In particular, we looked in more detail at the difference between the spot rate of a currency pair and the interest rate of the two currencies - part of that currency pair.
So that’s the quick refresher course. Now let’s look at the various options you have when it comes to hedging your currency exposure.
Managing currency volatility
When you invest internationally (for example, in non-Sterling denominated securities), you need to be mindful of the impact of exchange rate volatility on your portfolio. Of course, the impact can either be positive or negative, but you need to understand what’s driving it and decide if, and to what extent, you want to mitigate this risk. Your risk appetite (with regards to exchange rate risk) should be spelt out in your currency hedging policy, so as a pension fund you can show a considered approach to dealing with this type of risk.
In the past, only the very largest pension funds had access to the tools necessary to hedge their currency risk. But that’s all changed over the last few years and hedging services have become much more ubiquitous. So, what are your options?
First, the decision as to how and what currencies you want to hedge needs to be decided by your pension fund in combination with your investment adviser. Having considered the currency risk, some may conclude that it’s a zero-sum game and they don’t want to hedge any of the currency risk in their portfolio. As with all risk mitigation tools, you can never hedge out all the risk entirely. You need to achieve the right balance.
At KAS BANK, we do things rather differently. Many pension funds think an overlay strategy to mitigate foreign currency risk is difficult to implement or hard to manage. But that needn’t be the case.
For example, if you are investing in a pooled fund run by a fund manager, you may be stuck with the hedged share class, where the hedging strategy is solely defined by the manager. Of course, choosing to invest in the hedged share class does provide hedging of the currency exposure. However, the solution set cannot be tailored to your specific hedging strategy, resulting in a sub-optimal situation with regards to the specifics of the pension fund.
However, if you were to invest in the non-hedged share class of that same pooled fund, KASHedge - KAS BANK’s automated and simple overlay platform - could then tailor a hedge based on your specific hedging strategy. This also enables you to retain full control of your investment, including the hedge to mitigate your foreign currency exposure, however complex its structure. Not only that, we can also provide you with ongoing monitoring and reporting on the hedge that is in place via KASHedge. Ultimately, it’s all about offering you the flexibility to go into whatever hedge category you want, including a fully tailored hedge to mitigate foreign currency exposure.
In short, KASHedge can support you by providing transparent, cost effective solutions that mitigate your foreign currency exposure and create the most appropriate currency overlay structure for you, while leaving you in complete control of your strategy.