Case study. 
Looking through.
Aggregating. Hedging.

Initial situation.
The reporting currency only partially reflects currency risk.

The globally diversified Private Markets portfolio of an institutional investor comprises investments in private equity, private debt, infrastructure and real estate. The investments are spread across numerous target funds and holding structures with different reporting currencies.

Based on the reported fund and share class currencies, the currency risk initially appeared to be dominated by the euro and the US dollar. However, the underlying companies and projects are spread across different currency areas. A fund’s reporting currency indicates the currency in which it is managed and settled – not the currency risks to which the underlying investments are actually exposed.

7orca’s task was to determine the economic currency exposure of the portfolio, establish a recurring process for determining it and integrate the relevant currency positions into the investor’s existing FX Overlay.

7orca approach.

FX Exposure Management with FX Look Through.

Considering fund or share class currencies alone does not provide a sufficient basis for determining the economic currency exposure. Looking through to the underlying investments provides the basis for identifying the relevant economic exposure. Financing and hedging structures must also be taken into account: local-currency financing can act as a natural hedge, while fund managers may already hedge currency risks at fund level as part of their hedging policy.

7orca connects with the asset managers of the target funds and collects the information required to determine the exposure. Data formats, delivery frequencies and transmission channels are agreed with the managers, establishing the basis for a standardised and recurring process.

The exposure determination follows four steps.

• Connecting with the asset managers and collecting the required data
• FX Look Through: allocating market values to the currencies of the underlying companies and projects
• Taking risk-mitigating factors into account: local-currency financing and existing currency hedges at fund level
• Aggregating net currency positions at overall portfolio level and integrating them into the FX Overlay

Conclusion.

From 3 visible currencies to 26.

The impact of FX Look Through can be illustrated using a private equity portfolio comprising around 70 funds. At share class level, the portfolio appears to be almost entirely concentrated in the euro and the US dollar: EUR and USD account for 96.46%, with a further 3.54% attributable to the British pound. No other currency exposures are visible at this level.

After FX Look Through, the combined share of EUR and USD falls to 65.51%. GBP exposure rises from 3.54% to 11.89%. At the same time, numerous additional currencies become visible, including CNY, KRW, CHF and SEK.

Three figures summarise the difference.

1. 96.46% → 65.51%: share of EUR and USD before and after FX Look Through
2. 3 → 26: currencies visible in the portfolio
3. 22.61%: share of the portfolio attributable to currencies other than EUR, USD and GBP that were not identifiable at share class level

A hedge based solely on share class currencies would have overestimated EUR and USD exposure and underestimated exposure to other currencies.

Client benefit.

Hedging on the appropriate basis. An ongoing process rather than a one-off analysis.

The FX Overlay is based on the economic net currency exposure relevant to the investor – not on positions derived from the funds’ reporting currencies. This avoids inappropriate hedge decisions that could result from considering share class currencies alone.

At the same time, the process provides a robust basis for decisions by the management board, investment committee and supervisory bodies. Decisions on hedge ratios can be supported methodologically, documented and updated in response to changes in market conditions, asset allocations or risk budgets.

The benefits arise at three levels.

1. Hedging basis: The hedge is based on the portfolio’s economic net currency exposure rather than on the funds’ reporting currencies.
2. Process: Established data delivery and update processes ensure that changes in the underlying investments are reflected regularly in the exposure determination and in adjustments to the relevant positions within the FX Overlay.
3. Operational relief: 7orca handles the collection, preparation, plausibility checks and processing of heterogeneous data. This reduces operational effort and associated process risks for the investor.

Not an isolated case.

Findings from around 500 Private Markets funds.

The differences identified in the client case are not an isolated occurrence. An analysis conducted by 7orca of around 500 Private Markets funds held by investors in the DACH region shows a comparable pattern:

• At share class level, EUR and USD account for 99.25% of the currency universe.
• After FX Look Through, their combined share falls to 82.63%.

For Private Markets funds investing internationally, the share class currency is generally not a sufficient indicator of the actual economic currency exposure.

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