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Innovative Currency Management

With the right partner handling increasing FX challenges and managing related volatility, portfolio managers and funds can do what they do best – focus on investment decision.

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Northern Trust

Northern Trust

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The thing about capital markets is that they are global, and since time immemorial, whether it was sea shells or gold coins or today’s 180 currencies worldwide, capital has come in all shapes, sizes, and values – and is as different from one place to the next as languages and dialects.

Of course, when it comes to raising money or providing capital through investment, participants in these markets are an intrepid bunch. A business in need of capital, in many cases, doesn’t want to limit its investor base to only those who use local currency. Nevertheless, the risks and intricacies of currency exchange when an investor base is global are, to say the least, significant.

“Portfolio managers want to be concentrating on their core investment strategy, picking the right equity and fixed income instruments,” says Andy Lemon, Head of Transactional FX at Northern Trust Capital Markets. “Worrying about the uncorrelated operational cost and risk of managing currency volatility isn’t really part of that core focus, and is often viewed as an administrative burden. As such, it may not be given the level of focus that it requires. As the size and complexity of the footprint of an investor base grows into new geographies, some of these currency exchange models can become quite complicated.”

Hedging through a trusted partner

Delegating the nuances and heavy lifting of currency issues to a trusted partner allows portfolio managers to explore opportunities wherever they find them – not to mention time to explore more of them.

When Northern Trust Capital Markets is that partner, as it is to many, it brings a broad range of currency management solutions to the table, to support currency management risk mitigation: unhedged share class conversion, share class hedging, portfolio overlay, and look-through hedging make up the solutions suite. Northern Trust’s flexible and scalable solutions are tailored to meet specific client needs. “Understanding the client need is one of the most important aspects of setting up a currency management program,” says Lemon.

“The whole concept of managing that currency risk, is to reduce that impact of currency volatility on the performance of the portfolio and associated currency share classes,” says Lemon. “For the manager, the choice of whether to delegate to a specialized provider is one thing, but effective oversight is essential, and for that you have the right tools for the job, to be able provide detailed analysis to enable a consistent feedback loop. And that’s one of the key attributes of The Northern Trust offering. That’s really crucial because giving the managers the right tools supports them as they grow, increase distribution of their funds, and attract more investors from new jurisdictions.”

Going back to the basic concepts, unhedged share class conversion is a spot conversion from the share class into the fund base currency. The other three hedging techniques are more sophisticated. Take share-class hedging, for example. Suppose a manager in the UK wants to take investor inflows from the EU. They may issue a Euro-denominated share class to attract more investors. The Euro share class performance might differ from the Sterling share class – the base currency of the fund – so Lemon and his colleagues look to hedge the share-class currency back to the base currency of the fund to reduce the impact of that currency volatility, “The aim is to reduce performance divergence – and for this you need to be able to understand and analyse the key attributes that can cause divergence” says Lemon.

“The portfolio overlay for the same fund would be hedging between that Sterling base currency and the portfolio asset currency, which may be in Hong Kong Dollars or U.S. Dollars, or wherever that buyer has purchased that equity,” says Lemon.

A look-through hedge can be seen as a “combination of share-class and a portfolio overlay,” Lemon says. “Technically, what you’re doing is reducing the impact of situations where triangulating may occur. Suppose a U.S. investor is investing in the same fund through a USD Share Class, and 40% of that fund is invested into the U.S. market. You don’t need to book FX for that 40% of the share class because it’s already in the right currency. So, all you need to do is then invest from U.S. dollar share class into the other currency in the portfolio, which may be Swedish Krona, Hong Kong Dollar, Brazilian Real, or whatever. That’s what creates efficiency in the look-through hedge.”

Relentlessly striving to innovate

Accuracy and timeliness are important in the FX space, and to achieve those Northern Trust Capital Markets provides the full toolbox and skill sets. Despite its heritage, outstanding reputation, robust framework, and scale as an FX solutions provider, Northern Trust Capital Markets is always looking to up its game through innovation. In June, Northern Trust Capital Markets announced a technology partnership with Lumint, a business that provides comprehensive currency management services via a highly automated proprietary platform, including real-time performance analytics.

The Lumint partnership is yet another example of where Northern Trust is using innovative technology partners to ‘stand out from the crowd’ and address specific client needs. “It’s a competitive market out there,” says Lemon. “At the end of the day, as a portfolio manager, when you’re trying to attract investors through increased distribution, you need to focus on key skills, so when you make the decision to hedge and reduce currency volatility and decide to appoint a third party to handle this, then you want a partner whom you can rely on to do this right.”

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