Case Study.
Hedging impact. 
Costs. Liquidity.

Initial situation.
Existing hedging approaches with cost and liquidity implications.

An institutional real estate manager managed a globally invested real estate portfolio with a significant investment focus on the United Kingdom and was therefore particularly exposed to ongoing GBP/EUR currency risk.

The currency risk was initially managed in-house. In the first phase, the client used a static hedge based on FX forwards. The approach was later changed to GBP put options, allowing the client to retain participation in a potential appreciation of sterling.

Both approaches involved material trade-offs. The forward hedge created an ongoing drag on performance due to the negative interest rate differential between GBP and EUR and could require significant liquidity when sterling appreciated. The put option strategy retained upside participation but involved recurring premium costs.

Against this background, the existing hedging approach was to be reassessed, with investors expecting the FX Overlay to be transferred to a specialised currency manager.

7orca approach.

Comparing four hedging alternatives.

Using historical data, 7orca compared four hedging alternatives.

• unhedged position
• forward
• GBP put option
• zero-cost collar

The analysis considered the protection profile, advantages and disadvantages and liquidity requirements of each alternative. 7orca also assessed liquidity requirements during the GBP stress period of 2014/2015, when sterling appreciated by around 15% against the euro.

The analysis made the respective trade-offs transparent. The forward hedge provided full protection against depreciation but eliminated participation in an appreciation of sterling and had the highest liquidity requirement in the stress test considered. The put option combined protection with full upside participation but required an option premium and showed the lowest liquidity requirement in the stress test.

The zero-cost collar combines the purchase of a GBP put option with the sale of a GBP call option. The premium generated by the sold call reduces the cost of the put option. At the same time, participation in an appreciation of sterling is retained up to the call strike. This is offset by residual risk down to the put strike, limited further upside participation and potential margin requirements arising from the short call.

On this basis, 7orca developed a hedging strategy for the client using a zero-cost collar approach that balances hedging impact, costs and liquidity requirements within a defined structure.

Client benefit.

Decision-making framework. Liquidity profile. Ongoing support.

The benefit extended beyond the selection of an individual hedging structure. The different hedging approaches were translated into a transparent and historically grounded basis for decision-making that considers hedging impact, costs, liquidity requirements and operational implementation within a common framework.

Compared with the static forward hedge previously used, the zero-cost collar showed lower liquidity requirements in the stress scenario analysed. At the same time, the limitations and trade-offs associated with the structure – particularly in terms of upside participation, residual risk and potential margin requirements – were made transparent.

7orca provides ongoing support for the strategy across advisory and structuring, implementation and execution as well as monitoring and reporting. This also addresses the investors’ requirement for the currency risk to be managed by a specialised and independent manager.

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