Evening Brief – 10.02.03
Don’t Forget FX Volatility
While bond market volatility has received much attention in recent days and weeks, currency risk has emerged as another top priority for fund managers, particularly in the lingering aftermath of the March banking crisis. More than 80% of firms are now taking action to diversify their counterparty risk, and more managers are looking to implement hedging programs.
The global banking instability witnessed in the first quarter, precipitated by Silicon Valley Bank’s bankruptcy and rival UBS’s takeover of Credit Suisse, rippled throughout the financial services industry, including hedge funds and other alternatives.
As bank volatility increased, many prominent macro and trend-following hedge funds suffered double-digit losses, while equities short sellers profited by more than $7 billion. As a result, currency volatility and FX hedging have become more prominent following the banking turmoil.
MillTechFX, an FX-as-a-Service provider, polled over 250 senior decision-makers at asset management firms across North America about how they deal with FX volatility, hedging, exposures, and challenges.
With currency volatility expected to continue, the study — The MillTechFX North America CFO FX Report 2023: The Intensifying FX Challenges for Fund Managers — discovered that 40% of fund managers now consider FX to be “very significant” to their business, with another 49% considering it “somewhat significant.”
According to about 82% of respondents, US currency fluctuations have had an impact on their business. With ongoing volatility having the potential to undermine bottom lines, particularly for North American managers trading in US dollars, the study examined how fund managers are reducing risk.
More than four out of every five fund managers intend to diversify their foreign exchange counterparty risk. Over two-thirds of managers already have a hedging program in place, and more than half of those who do not have one are contemplating creating one.
According to the survey, fund managers’ FX exposures are derived from a variety of sources, including investor share classes (51%), management fees (48%), foreign currency assets (44%), and within portfolio firms (43%).
“Fund managers are taking positive action to diversify their counterparty base to avoid having all their eggs in one or two baskets,” said Eric Huttman, CEO of MillTechFX. “This not only mitigates counterparty risk, but also provides them with more options, enabling them to compare prices, get more transparency and achieve best execution.”
According to the report, the average hedge ratio is presently between 50% and 59%. Almost 70% of fund managers reported that their hedging ratio was higher than it was the previous year. Meanwhile, the average length of hedges was 4.96 months, which was longer than the previous year. In addition, two-thirds thought the cost of hedging has increased.