Fund managers have different foreign exchange requirements than Corporates as foreign exchange exposures occur because of investment activities as opposed to trade activities.
They are often working within a benchmarked framework and managing foreign exchange risks incorrectly can give rise to unwanted and unexpected deviation on returns even when trying to stay at benchmark. Fund managers should be aware of not only the benchmarks set for them but how to manage to the benchmark return. This is often more complex than may first appear as benchmark indices are set periodically and fund size changes can affected the currency weighting in unexpected ways.
Most fund managers run international bond portfolios fully hedged which means that for every foreign bond exposure they have a corresponding hedge in place. Usually the hedge takes the form of a forward sale of foreign currency for their home currency normally on a rolling three month basis.
In practical terms, this means that on purchasing a foreign bond, the fund manager should enter a swap or (FX forward) contract. This means that on the near leg of the swap they can buy the foreign currency against their currency (to pay for the bond) and the second leg is for the sale of the foreign currency against the their currency and neutralises the FX risk.
NB: Fund Managers may execute a spot to buy the foreign currency and then an outright deal to sell the foreign currency forward - the net effect is the same as a swap except the fund pays an unnecessary spread in the spot market. Once the hedges are due for settlement, the fund simply executes another swap. The near leg is equal and opposite to the maturing deals (except the rate is now the current spot) and the second example reinstates the forward hedge.
The portfolio manager also needs to decide which currency to keep constant, their currency or the foreign currency. In general it is the foreign currency which should be kept constant in line with the value of the bond holdings. If the foreign currency hedge amount is kept constant, be aware that each roll date will give rise to an currency profit or loss on the hedge. Also at each roll date the value of the foreign bond needs to be taken into account and the hedge adjusted accordingly to make sure the portfolio is not over- or under-hedged.
However when a fund manager is running a portfolio unhedged, foreign currency should be bought and sold as needed to satisfy the underlying transaction. These transactions should be executed when the underlying assets are purchased or sold and have value dates matching the settlement terms of the underlying asset, for example in equities it's usually T+5.
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