Following the recent record-breaking market drop, Reuters published this article related to an increased awareness by fund managers of the importance of effective currency hedging and exposure management. While an afterthought for many, a minority of managers appreciate the alpha generation that can be recognized when managed in an efficient manner. For too long, many managers view currency risk much like they view the weather. They can research and prepare but at the end of the day there is not much they can do about it. I addressed this element of begrudged acceptance in my book, Hedging Wisely :
“Investors have all too readily, and for far too long, shared the mentality that currency risk is a built-in reality that simply has to be accepted. Sometimes it plays out in their favor, and sometimes not. Some Investors expect their Managers to have something in place to hedge their currency, but that something is often not well defined, let alone scrutinized or evaluated or compared to alternatives. As long as the box marked currency hedging is checked, a Manager is considered to be qualified. Don’t our Investors deserve better? Shouldn’t the experts actually be qualified? Arguably it’s the Investor’s responsibility for not asking more questions, not examining currency risk more closely, and not expecting more from the Managers than merely check a box. But if I were the Investor (and of course, I am!) I would counter that argument with my own argument that my naivety is why I hired you, the expert. The Investor’s lack of knowledge can’t be penalized or used as an excuse not to do a better job, when that same lack of knowledge is why they employ financial professionals in the first place. They don’t know how to hedge currency risk, and they shouldn’t be expected to or we will all be out of work. That’s why they hire experts. So let’s be those experts”
To be clear, by “expert’, I don’t mean you need to be a Macro-Economist or a Ph.D. in mathematics, or even a currency expert per se. There’s a distinction between currency experts and expert currency hedgers. Our mission at Wise Trading Tech is to empower every investment manager with an intuitive tool to efficiently manage their currency exposure and risk at a justifiable cost. We believe non-experts shouldn’t need to understand the complexities of currency exposure any more than they understand the complexities of their wifi service. Like transaction costs or exchange fees, currency management is an unavoidable element of the investment process. And like TCA and Best Execution, the costs associated with currency management can be quantified by those managers who are proactive in the process.
Regret theory is a term being popularized in the currency community. Why now, and why in the currency markets?
More Nuance Than Traditional Economics
Traditional economics is based on assumptions around individuals behaving in a rational way, maximizing a utility function inside a set of constraints, rules, that are constantly being weighed and prioritized. But newer behavior economic theories and research into decision making is exploring how people make decisions when information or resources are limited, and how we are all biased. Important questions are being raised regarding how the human mind responds to making difficult decisions in uncertain conditions.
What is Regret Theory?
Regret theory is a part of this somewhat newer science.Regret theory centers on the fact that people are afraid of making wrong choices, and so the fear of regret drives suboptimal decisions. And regret theory works in both directions – making some people more risk-averse and protective, and others more aggressive due to ‘fear of missing out.’
How Are Portfolio Managers Managing Regret?
There are other ways to avoid or mitigate regret in currency hedging, or more broadly in investing in international securities. One is to do copious research and spend time trying to manage down risk by becoming an expert in currencies. However, in reality, portfolio managers need to be experts in stock selection, and very often don’t have or don’t want to spend time on acquiring the skills needed to apply currency trading expertise.
Some have suggested that a 50% currency-hedged portfolio may be the ‘hedge of least regret,’ as it allows for lower volatility in the more volatile markets, while still allowing for some upside – or downside. Every asset manager, and perhaps every portfolio manager, has a different policy when it comes to the management of this risk.
How WiseRisk Can Help
Once that decision is made, how is a manager to ensure that this policy is being followed up on – again, without having to constantly check markets and become a currency expert? This is where WiseRisk can help. With WiseRisk, you can choose what percent hedged you’d like to be. If that preference changes, you can trigger a manual rebalancing at the time you need to – or set rules about when the policy might change; for example, in times of greater volatility. We at Wise Trading Tech are here to help and answer your questions and implement your strategies to master those regrets.
Are Your Returns in the Same Currency as all Your Clients’?
In a recent article on Bloomberg.com, Liz McCormick leverages an example of how the Nikkei 225 stock average to portray how returns can be impacted by converting the returns to USD and the Euro. The index, which was up 16.7% in dollar converted terms, would have a return of 13.5% to those in yen, but only 8.6% in Euro, due to the appreciation of the Euro against the yen.
..That Can Make the Difference Between A Good and Bad Year
As you can see from this example, the difference between beating market average returns and under or overperforming can be driven by the ‘home’ currency’s changes versus the denomination of the investment. As an asset manager, you can get a lot of factors right, but near-term moves in currency may mean that hedging can ensure that the resulting gains remain gains. While lack of currency management can also result in unexpected gains, this is not typically a risk that is desired by money managers or their customers as part of their strategies unless explicitly sold that way.
Max Kettner comments in this and other articles about the excitement about the strength of the euro in 2017 and the potential expectations about 2018. There are risks when a currency strengthens, besides outsized expectations, like the one above – a dampening of international fund returns.
Outsourcing That Risk Has Become Its Own Problem
So what are asset managers to do? Faced with the potential to outsource this risk, some managers have turned to sell-side banks. However, as we noted in our recent blog about lawsuits in the industry, the tide of sell-side banks being penalized for cheating the buy-side continue. By recent example, Credit Suisse will have to pay $135 million to settle the New York Fx investigation.
We Are Here to Help
At Wise Trading Technologies, we believe cost-effective tools to manage currency risk and gain transparency into potential areas of exposure are a must for the industry. Our WiseRisk product was designed with all of these market dynamics in mind, helping asset managers who want to manage currency risk avoid the pitfalls of outsourcing. For more information, contact us at firstname.lastname@example.org.
At Wise Trading, we like to share articles of interest from the many we see. We hope this is helpful to you in keeping up with issues and thinking on currency hedging.
US Investigating FX Trading at Wells Fargo (FoxBusiness.com)
Switzerland’s Old Money Problem (wsj.com)
Have a great November, we’ll keep our eyes and ears open for news of interest. Please check out our twitter feed @wise_risk for more market intelligence.
Is your Corporate Treasury protected from currency fluctuation? Asset pools, such as defined contribution plans and corporate treasuries, that have not traditionally been known for their currency hedging strategies. The increasing volatility in the currency markets is changing this. What’s more, there is no one way that corporate treasurers track their ‘fx footprint.’ That means there is an opportunity to create some standardization in an industry where even decisions on how to apply the accounting rules related to foreign holdings can be unclear at times.
What’s Hedged, What’s Not
Historically, it’s been common for pensions and other investment funds to administer a currency hedging strategy to guard against currency fluctuations. However, as of late, maintaining these strategies has become increasingly complex and critical. Portfolio Managers of global assets and corporate treasurers, in particular, are struggling with currency hedging and risk management because of a lack of automation in their antiquated processes.
It should come as no surprise that projects are being initiated to evaluate off-the-shelf financial technology solutions to centralize and automate the processes and tasks related to currency risk management. Given the choice to build versus buy, firms are choosing to buy. Firms are recognizing the need to focus on their core competency of producing positive returns on managed assets. The intrinsic and extrinsic costs of building and maintaining proprietary systems outweigh the nebulous expected ROI of an internal build.
An Increase in Proactive Currency Management?
In the face of this increased complexity and globalization, we expect to see a demand for currency hedging on the part of small and midsize institutional investors in their operational due diligence. Since the crash of 2008, investor demands transparency have continued to increase. Investor tolerance for spreadsheets and ad hoc homegrown solutions has been largely eliminated. Any identified inefficiencies are viewed by investors as drags on returns. And for the past decade, there has been awareness amongst managers and their investors regarding FX trading and execution.
This is more than a story about currency becoming an asset class in its own right. Recent news has raised the awareness amongst managers and their investors regarding the accepted and questionable practices in FX trading and execution. With a plethora of managers to choose from, investors are demanding more in all facets of their manager’s operations. When it comes to FX management, there is an opportunity to be leveraged by the manager who can demonstrate automation and efficiencies. Too many managers are still relying on too much manual intervention and processes that investors realize are inefficient and error-prone.
If More Automation is Preferred in FX Management, WiseRisk Can Help
WiseRisk was created for any manager that wants more precise insight into their currency exposure and risk with the ancillary benefit of diminishing costs associated with outsourcing the trading to the Street. The proliferation of SaaS tools and platforms has empowered managers to take more control in the areas of portfolio optimization and trade execution. WiseRisk offers these same advantages for managing currency risk and exposure.
Please send us a note at email@example.com us demonstrate how WiseRisk address your current needs in FX management.
Another Case of Rigging Foreign Currency Trades Plays Out in Court
In a case that started about a week ago, the most recent in a string of lawsuits related to sell-side management of currency hedging is playing out. The rigging of another foreign currency trade may make another banker a felon. These lawsuits, many large, public and successful, continue because of inherent problems in the market structure where buy-side banks depend on sell-side banks for sourcing their currency requirements. This might not happen so often were it not for the limited options asset managers have to manage currency risk.
In July of 2016, HSBC’s head of global foreign exchange (FX) cash trading, Mark Johnson, was arrested at Kennedy Airport on charges of wire fraud tied to a $3.5bn FX transaction in 2011. According to the DOJ, the traders put their own and company interests ahead of the trust and confidentiality owed to their client, and in doing so, defrauded their client of millions of dollars. When questioned by their (not named) client about the higher price paid for their significant transaction, the defendants attempted to conceal the truth and divert attention away from their fraudulent trades.
And a Not So Happy New Year…
While these cases have been playing out in the last 5 years, what distinguishes this case is the degree of egregiousness and the overall attitude of the trader involved. According to reporting on the subject,
“Johnson himself said the order was like “f***ing Christmas” in internal communications.”
Johnson has also used as his primary excuse that the behavior he exhibited is rampant in the industry.
Buy Side Banks Need Options, and WiseRisk Delivers
While asset managers can take consolation in the success of the lawsuits, wouldn’t it be better if currency risks were addressed in a way that did not depend on the better nature of sell-side traders? Our CEO addresses these exact issues in our recent webinar, Masters Series: Rohanna Wise on her book, Hedging Wisely. She created WiseRisk in order to offer just such an option.
We built cost-effective technology that enables customers to focus on their core value proposition without becoming or hiring currency experts, nor compromising on the quality of their currency exposure management, either by managing risk with lesser tools or outsourcing to the sell side.
We wish you happier holidays this year.
We are going to have a webinar with Rohanna Wise, founder of WiseRisk, as the second episode of our Masters Series.
We will be mainly talking about Rohanna’s new book, Hedging Wisely. The webinar is on September 28th, 12pm EST. so save the date and sign up here.
To receive information about future webinars, join the WiseRisk Community here.
From time to time, we like to share articles of interests from the many we see. We hope this is helpful to you in finding recent standout issues and thinking on currency hedging.
Have a great September, we’ll keep our eyes and ears open for news of interest. Please check our twitter feed @wise_risk for more market intel and thinking.
From time to time, we like to share articles of interest from the many we see. We hope this is helpful to you in finding recent standout issues and thinking on currency hedging.
Have a great August, we’ll keep our eyes and ears open for news of interest. Please check our twitter feed @wise_risk for more market intel and thinking.
At Wise Trading Technologies, we want asset managers to be able to implement their own effective currency hedging strategy; all those involved in investment will be able to participate in global markets regardless of their level of currency expertise.
When investors participate in global markets, they take on exposure to currency markets. When an investor has investments and clients in multiple currencies, maintaining an accurate hedge can be extremely difficult with much to juggle. Hedging Wisely: A Non-Expert’s Guide to Expertly Hedging Currency Risk serves as a guide to how to choose, implement, and maintain a hedging strategy. Hedging Wisely examines issues such as an increasing interest in the impact of currency, the effect of currency on investors’ portfolios, the consequences of devaluation in China, negative interest rates, and interest in emerging markets.
Wise Trading Technologies CEO and Author Rohanna Wise has been working in trading technology and automation for the last 20 years, and is the founder and CEO of Wise Trading Technologies. Rohanna will present hedging strategies which the reader can easily use to protect themselves from risk when investing in global currency markets.