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A primer on hedged share classes

It is becoming increasingly commonplace for asset management companies to launch sub-funds with varying share classes. These could differ for a number of reasons, namely:

• Accumulator or Distributor Share Classes
• Retail or Institutional Share Classes
• Hedged or Unhedged Share Classes

The total return performance of fund can be reported in an array of currencies in which a share class is launched, as investors invest in those share classes which suit their needs.

For example, a Malta-based investor, whose income and expenses are pre-dominantly in euros, might prefer to invest in a USD-denominated fund, such as a US bond fund having a share class in EUR rather than the USD share class.

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.

To mitigate this risk, asset managers engage in what is known as currency hedging. This is a way of minimising the impact of these exchange rate movements, which theoretically remains removing some of the uncertainty of investing by 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 important to note that no hedging strategy is 100% perfect and that no hedging strategy will eliminate currency risk entirely. Differences primarily relate to costs and the type of instruments used, amongst other things. So a USD share class and a hedged EUR share class (hedged at share class level) will move practically in line, bar 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 in the share class currency.

Hedged and unhedged share classes are created so as to give investors that extra flexibility in their investment choices. All in all, each investor will look at his individual circumstances to determine which type of share class to invest in.

But 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, 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.

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 aimed at reducing underlying currency exposure, and hence will 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 is 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. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.

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