DEVISING THE RIGHT STRATEGIES
Since hedging is a risk management tool, with associated costs, global asset managers looking to build out their Asia-focused products and services will increasingly need to consider the objectives, targets, tools and impact of managing currency risks, and the capabilities necessary to execute hedging for given Asia funds — or whether there may be demand for both hedged and unhedged versions of the same fund.
If currency hedging is appropriate, a robust strategy must take into account a number of key considerations. To start with, fund managers should evaluate whether to hedge at the portfolio level or at the individual asset level, and whether the purpose of the exercise is to hedge cashflows from the asset or debt at the asset level. These decisions will, in turn, impact the choice of hedging instruments used.
Next they will need to determine the expected asset valuation and a timeline, which should be matched to the values, tenors and timing of the hedging tools in order to deliver anticipated returns.
Naturally, fund managers should also ensure there are sufficient financial resources to settle FX hedging obligations. There is a risk that market movements in the value of the asset and the exchange rate of an emerging market currency could result in substantial shortterm cash requirements, depending on the hedging tool used for a particular transaction.
Working with highly rated counterparties to mitigate credit risk is also important, particularly with long-dated hedges. It is noteworthy that the credit profile of both counterparties affects credit limits and credit charges, which are usually incorporated into hedging transaction prices.2
In the current market context, making the assumption that returns on Asian assets will comfortably obviate the need to consider the impact of currency movements is no longer an option. Hedging will therefore be an increasingly valuable tool in managing currency risk and creating long-term value, and a source of competitive edge, for asset managers building out their Asia offerings.