For those investors within the industry as well as for those seasoned investors who are familiar with the funds market, foreign funds in particular, will note that it is becoming increasingly commonplace for asset management companies across the globe, to launch sub-funds with a differing number of share classes.
These vary in type for various reasons; either income accumulating (accumulator) or income distributing (distributor); retail or institutional share classes; and more recently, there has been an increasing trend in issuing hedged classes as opposed to the traditional unhedged share classes.
It is conventional for the performance of a fund to be reported in an array of currencies in which a share class is launched, as each investor will choose to invest in those share classes which suit their needs.
Take a local investor for example, whose day-to-day income and expenditure are more often than not in euros, this is typically the case. S/he might however prefer to invest in a USD-denominated fund, such as a US bond fund or US equity fund having a share class in EUR rather than in the USD share class.
Such investor would be willing to take on the market risk of investing in US securities but wish his/her investment to be EUR based. In such cases, investors who choose a different currency to that of the fund's investment strategy do so at the expense/risk of having their investment returns influenced by exchange rate movements between the currency of the fund's investment strategy and the currency of the share class.
There are ways whereby asset managers can mitigate this currency, and that is by entering into transactions known as currency hedges. This is a way of minimising the impact of these exchange rate movements, which serves to remove some of the currency-related risks, thereby permitting an investor to be exposed to the performance of the underlying assets, without the additional risk of being exposed to unnecessary/unwarranted currency fluctuations.
It is of utmost importance to highlight that no hedging strategy is 100 per cent perfect and therefore currency risk is not eliminated in its entirety. Differences primarily relate to costs, the type of instruments used, amongst other things. This means that a USD share class and a hedged EUR share class (hedged at share class level) will move practically in tandem, in the absence of any cost-related adjustments.
The return an investor will be exposed to is a mix of the performance of the underlying asset/constituents of the fund, as well as the impact of any currency movements at fund level.
Hedged and unhedged share classes exist to give investors that extra flexibility in their investment choices. All in all, each investor will look at his/her individual circumstances to determine which type of share class to invest in. Ongoing expenses between hedged and unhedged share classes should be practically identical, with the hedged share classes being that little bit more expensive as the NAV will have the embedded hedging costs, but that is more than understandable.
What investors need to keep in mind is that currency hedging may decrease or increase a share class’ performance vis a vis that of an unhedged share class. In particular and this point is critical, is that currency hedging may substantially limit currency hedged share classes from benefitting if the currency of the currency hedged share class falls against a sub-fund’s base currency or the portfolio’s currencies. Consequently, non-hedged share classes can profit from currency movements, and investors in currency-hedged share classes may miss out on additional gains in these circumstances.
From an asset management perspective, the process of hedging at share class level has no impact on the management of underlying assets in the sub-funds offering NAV hedged share classes because it is the NAV of the relevant share class which is hedged, and therefore not the underlying assets of the sub fund as a whole. This means that portfolio hedged share classes are hence aimed at reducing underlying currency exposure, and will therefore generate varying levels of performance to the sub-fund’s unhedged share classes brought about by the different currency hedge positions.
Disclaimer:
This article was issued by Mark Vella, investment manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.