Case study – 7orca Private Markets.
Determining the economic FX exposure.
The client’s challenge.
The Private Markets portfolio of an institutional investor is globally diversified and comprises investments in private equity, private debt, infrastructure and real estate. The investments are spread across numerous target funds and holding structures with different fund currencies.
Based on the reported fund and share class currencies, the currency exposure initially appeared to be dominated by the euro and the US dollar. However, the investments are made internationally in companies and projects across different currency areas. The share class currency therefore does not necessarily correspond to the actual economic FX exposure.
7orca’s task was to identify the economic FX exposure of the Private Markets portfolio, establish a recurring process for determining it and integrate the identified currency positions into the investor’s existing FX Overlay.
The central challenge was to distinguish between the share class currency of a fund and its actual economic FX exposure. The fund or share class currency indicates the currency in which a fund is managed or in which settlement with the investor takes place. However, it does not provide a reliable indication of the actual economic FX exposure of the underlying investments.
For globally diversified Private Markets funds in particular, this can result in a considerably more complex currency profile. A private equity fund denominated in US dollars may, for example, invest in companies or projects whose exposure is attributable to the British pound, the Australian dollar or the euro. These currency exposures cannot be identified if only the share class currency is considered.
However, a look-through limited to the currencies of the underlying investments does not necessarily reflect the economic FX exposure either. Financing and hedging structures can alter the resulting exposure. Currency-matched financing, for example, can act as a natural hedge. At the same time, fund managers may hedge currency risks at fund level as part of their hedging policy. Both effects must be taken into account when determining the economic FX exposure.
Data availability represents an additional challenge. For Private Markets investments, information on market values, underlying currencies, financing structures and existing hedges is frequently available in different formats, with different reference dates and at varying levels of granularity. To determine exposure consistently, this information must be consolidated, checked for plausibility and aligned to a consistent methodological basis.
7orca’s solution.
The aim is to derive a consistent net currency exposure for the overall portfolio that reflects its economic position on the basis of heterogeneous fund and portfolio data.
The first step is to contact the managers of all investments held in the portfolio and collect the information required to determine the exposure. This establishes the basis for a standardised and recurring process for updating the currency exposure.
Based on the information collected, the relevant economic FX exposure is then determined for each investment.
As part of the look-through, the relevant currencies of the underlying portfolio companies or projects are identified and the respective market values are allocated to the corresponding currencies. Risk-mitigating factors such as local-currency financing and existing currency hedges at fund level are then taken into account.
Conducting a look-through for an extensive Private Markets portfolio can involve considerable operational effort. The large number of different data sources, reporting formats and investment-specific characteristics can also increase complexity and the risk of manual processing errors. By centrally preparing, checking and processing the information, 7orca performs these tasks for the investor, thereby reducing the operational effort and the associated process risks.
Based on the positions determined in this way, the relevant net currency exposure is derived for each investment. The individual positions are then aggregated at portfolio level and integrated into the investor’s existing FX Overlay.
Established data delivery and update processes allow changes in the underlying investments to be reflected regularly in the exposure determination and in adjustments to the relevant positions within the FX Overlay.
The client's benefit.
The impact of the look-through can be illustrated using the example of an investor’s private equity portfolio comprising around 70 funds. A comparison between a view based solely on share class currencies and the identified economic FX exposure reveals considerable differences.
Based on the share class currencies, the portfolio appears to be almost entirely concentrated in the euro and the US dollar. Together, the two currencies represent 96.46% of the portfolio. A further 3.54% is attributable to the British pound. No other currency exposures are visible at this level of analysis.
By contrast, the look-through reveals a considerably more differentiated currency profile. The combined share of EUR and USD falls to 65.51%, while GBP exposure rises from 3.54% to 11.89%. At the same time, additional currencies become visible that could not be identified at share class level. These include CNY, KRW, CHF and SEK.
The look-through considerably increases the granularity of the currency profile. While only three currencies are visible at share class level, the portfolio comprises a total of 26 currencies after the look-through. Around 22.61% of the portfolio is attributable to currencies other than EUR, USD and GBP that could not be identified through the share class view.
The differences between the share class view and the economic view are directly relevant to managing currency risk. In the portfolio under review, a hedge based solely on share class currencies would overestimate EUR and USD exposure and underestimate exposure to other currencies.
The look-through therefore provides a more robust basis for the FX Overlay. The hedge is based on the economic net FX exposure relevant to the investor rather than on positions derived solely from share class currencies. In addition, integration into the established data process allows changes in the investments to be captured regularly and reflected in adjustments to the relevant positions within the FX Overlay.
Context within a broader Private Markets universe.
The differences identified in the portfolio under review are not an isolated case. An analysis conducted by 7orca of around 500 Private Markets funds held by investors in the DACH region shows a comparable pattern. While EUR and USD together account for 99.25% of the currency universe at share class level, their combined share falls to 82.63% after the look-through. At the same time, other currencies account for a larger share of the currency profile.
The specific client case therefore supports the broader observation that, for Private Markets funds investing internationally, the share class currency is generally not a sufficient indicator of the actual economic FX exposure.
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