Macquarie FICCAM – Dynamic Currency Hedging
Accurate forecasting is near impossible
> Forecasting the future direction
and magnitude of currency
moves is very difficult.
> 8 out of 14 years, expert
forecasts misstheactual rate by
more than 10%.
> In many years experts get the
direction of the currency move
completely wrong (like in 2008)
A professional currency manager will
provide full hedging servicesto
protect your overseasassets.
1996 1998 2000 2002 2004 2006 2008
% missed in forecast (LHS) AUD/USD (RHS)
The high cost of wrong direction
> During the second half of 2008, the cost of having
the wrong strategy (hedged) versus those with the
right strategy (unhedged) was 34%.
> A wrong hedging strategy may bring a top
performing company to the bottomof the peer
> There is a high correlation between periods of AUD
depreciation and fall in asset value which makes a
wrong decision very costly and unmanageable.
- What happens if your assets are illiquid?
- How do you finance the drawdowns?
Can you leave a 34%fall
Source: Bloomberg. The results are calculated based on a MSCI currency basket from July 2008 to October 2008
Hedgeyour overseasassetsand choosethe
If you fully hedge, the P/L effect due to currency is neutralised.
The perfect hedge
> If you do not hedge, the P/L effect due to currency is maximised.
> Ideally you want to fully hedge when the base currency goes up and have
no hedge when the base currency goes down.
Dynamic Currency Hedging, the
A similar profile to the perfect hedge.
What is Dynamic Currency Hedging (DCH)?
> DCH is a systematic trend following strategy with limited
amount of manager discretion.
> DCH is a hedging strategy designed to minimise down side
currency risk while allowing to participate in the upside gain.
> The level of currency hedge changes as exchange rate levels
> Aims to achieve an option-like pay off over
a 12 month period.
> Primarily use currency forward contracts.
How does Dynamic Currency Hedging work?
If the AUD appreciates,
towards a hedge level of
If the AUD
towards a 0% hedge
A DCH’s return profile shows gains as the AUD rallies but limits downside
losses when the AUD falls
Big hedging losses & illiquid assets
When the base currency falls
and your forward contracts
mature you need cash to pay
> If your assetsareilliquid,
this might bedifficult to sell
> If your assets have
depreciated, it could be the
wrong time to sell
The AUD as a proxy for world growth
Source: Bloomberg, Morgan Stanley.
How DCH performed through the
largest AUD fall
> The DCH program quickly
lowered the hedge level in line
with the 40% fall in AUD late
> Our disciplined approach
means we were on the trend
as currency moved.
Hedge Level on Client Account (RHS)
Statistics 50%hedged DCH Unhedged Fully hedged
Total currency return* 17.0% 22.7% 30.4% 3.8%
Drawdown (realised loss) -13.5% -7.8% 0.0% -26.6%
Drawdown on $100m
-$13.5m -$7.8m $0 -$26.6m
Cash management when the AUD falls
*Equal to ‘realised return (from hedge) + unrealised (from assets)’
Source: Data taken from the track record of our longest running DCH client (since 1992), AUD versus currency basket.
30 Jun 2008 – 30 Dec 2008 (Period including the largest historical fall in the AUD)
> The wrong hedging strategy may bring a top performing company to the
bottom of the peer group.
> Funding the recent fall in the AUD using a static hedging strategy was very
> DCH significantly reduced the losses on the hedge and hence the need to
crystallise asset losses at a time of poor liquidity.
Dynamic Currency Hedging - Summary
Dynamic Currency Hedging, theultimatecurrency hedge
No need to forecast the currency direction
Limits losses on hedging as the local currency depreciates
Protects the foreign portfolio as the local currency appreciates
The hedging strategy with the best long term performance
Manageable cashflows with one settlement per year