Asset managers are increasingly challenged to reduce operating costs and risks, refine execution, and re-focus on core activities, while asset owners are searching for enhanced returns. Within this market context lies the opportunity to rethink currency management operating models. Mark Hogg, Head of Currency Overlay Services at RBC Investor & Treasury Services, proposes currency management considerations for both asset owners and managers.
Consolidated currency management
Currency management is integral to global investing. The fundamental starting point is the execution of Foreign Exchange (FX) transactions to settle the purchase or sale of foreign currency securities within a portfolio.
A central currency manager, that is custodian and asset manager agnostic, has the ability to consolidate these flows
This type of ‘operational FX’ activity has typically been bundled into investment managers’ in-house execution desks. Yet, there may not be sufficient focus on the top-down consolidated view to determine what might deliver the best aggregate results for their asset owner clients. For example, large asset owners that utilize multiple managers to support various elements of their investment strategies, may not be aware that FX transactions are being undertaken in the same currency, but in opposite directions. As these transactions are happening in disconnected venues and at different times, potential netting opportunities are lost. Crossing these flows would result in fewer individual market transactions, which lowers costs and translates into improved returns for the asset owner. Netting FX flows across multiple investment managers and/or custodians represents an opportunity for large global asset owners with fragmented execution models.
A central currency manager, that is custodian and asset manager agnostic, has the ability to consolidate these flows, preventing unnecessary trips to market to minimize execution costs. These savings accrue to the asset owner, while the asset manager benefits by reducing in-house FX desk costs and market execution risks freeing them up to focus on the core activity of managing client assets.
Beyond these real cost saving benefits, FX outsourcing also lends itself to a number of operational efficiencies, including standardized execution models and methods. Digital solutions provide enhanced transparency and one-stop oversight solutions, which can be further augmented with independent Transaction Cost Analysis (TCA).
Extending through to currency overlay solutions
Once the operational FX requirements to support security settlement are satisfied, the focus can evolve to include the management of the longer term currency risks inherent in multi-currency portfolios. Passive currency overlay provides a systemic and rules-based method, typically using FX Forward contracts, to mitigate the impact of changes in exchange rates when translating the market value of foreign currency assets back to an investor’s home currency.
It is also critically important to analyze the performance and the effectiveness of the hedging program over time
In combination with operational FX, currency hedging solutions can be consolidated and outsourced to a central currency manager who can minimize costs, reduce risks, improve execution transparency and standardize oversight. It is critical to partner with a currency manager that will work directly with the asset owner and their asset manager(s) to establish unique hedging program rules designed to deliver on their individual currency risk management objectives. Common questions to consider when establishing customized programs may include:
- What is the performance benchmark of the portfolio?
- What is the typology of the underlying assets?
- Which currencies to hedge?
- How often to rebalance the hedges?
- What is the hedge tenor?
- What is the minimum exposure size to hedge, or minimum trade size?
It is also critically important to analyze the performance and the effectiveness of the hedging program over time to ensure that the input rules established at the outset are delivering against intended objectives.
Next generation digital oversight
The burgeoning ability today to consume, process and visualize large volumes of data, then present that in intuitive, dynamic formats, has helped advance and facilitate more efficient oversight of currency management solutions.
Digitized solutions that present usable analytics, and visualization dashboards that can be tailored to the needs of end user groups greatly enhance user experiences.