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Forex Hedging for Funds:Protect returns and capital fromCurrency fluctuationsAlain GroshensSystematicEdgeCEO & Co-founderMay 5th,2020

Funds and Currency Risk:Who is concerned?AlainGroshensSys te mat i cEd geC E O & C o -fo unde rFunds and Currency Risk :Institutional investors face constant pressure todeliver returns and reduce costs. theirWhen speaking to Funds, we receive recurringquestions on how to protect returns and capitalfrom currency fluctuations:What kinds of funds are mostat risk ?What are the main types ofcurrency risks and costs thatone should be aware of ?Why hedge currency risks?Can you give us an exampleusing a real case study?What are the instruments andhedging strategies used tomanage currency risks?What is your unique valueproposition?WE AIM TO ADDRESS THESE IMPORTANTQUESTIONS, INCLUDING A CASE STUDY, IN THISWHITEPAPER.Institutional investors face constant pressure todeliver returns and reduce costs. They mustdeal with a range of challenges, including theimpact of currency volatility on theirinvestments.These investors include: Private Debt funds,Real Estate funds, Venture Capital and PrivateEquity Funds including their portfoliocompanies. Hedging considerations include:. Portfolio Currency Hedging: If the fund’sbase currency is in USD and the fund has themandate to invest in assets denominated inforeign currencies such as EUR, AUD, CAD,CNY and JPY, then FX hedging will neutralizethe impact of foreign exchange movementsbetween the USD and the foreigninvestment currencies, either totally orpartially, depending on the desired targethedge ratio.Share Class Currency Hedging: Investorswilling to invest in a fund with a basecurrency different from their domesticcurrency face a number of risks. These relateto the currency volatility between theirdomestic currency and the fund's basecurrency. The share class hedging processwill reduce the effect of FX volatility,ensuring that the performance of thecurrency hedged share class is consistentwith that of the reference fund. There willremain differences in performance becausehedging comes at a cost or a gain due to thedifference of the interest rates betweencurrencies. However, the performance ofthe hedged share class will be largelyimmune to the market variation of the FXrate between the share class currency andthe fund base currency.

Four Main Currency Risks & Costs to be aware of:There are Four main risks & costs linked to currency that can generate losses and recurring costs:01Currency Volatility:Currencies are volatile and theirfluctuations can wipe out the funds’performance and generate a capital loss.An extreme example of this was seen inthe first quarter of 2020, where majorcurrencies experienced large movesranging from 10% to 20%. For example:02AUSTRALIAN DOLLAR US DOLLAR0403Hedging carry costs:Depending on the currency pair, a hedgecan generate recurring profit or loss dueto the interest rate differential betweenthe currencies.Currency Conversion recurring costs:Currency conversion needed to purchaseassets in foreign currencies can in itselfgenerate recurring costs if the currencymarket is not accessed efficiently. Thathappens when the fund is not using DirectMarket Access to convert forex and isgoing through aforexsupplierintermediary involving layers of fees thatcan add up to many percent per year,eroding the fund’s profit margin.Counterparty risk:It is the elephant in the room that is toooften ignored and that can be fatal to afund using the wrong FX provider. SomeForex providers use currency DeliveryVersus Payment (DVP) where the fund willwire out from its cash account the fullamount of currency to be converted bythe FX supplier and therefore bear a 100%counterparty risk on the amount sent.Why hedge currency risk?In order to reach its risk adjusted return objective, a fund must eliminate the currency risks thaterode returns and can generate capital loss as well as recurring costs.How to do it and what is the objective of hedging currency risk ?Currency risks must be analyzed in the funds’ strategy context, return objective and risk mandate socurrency conversion and risk hedging can be planned and implemented using an efficientoperational solution with the objective to: Immunize the fund’s capital and returns from currency volatility. maximize the fund’s risk adjusted returns. minimize the portfolio management costs.

Case Study:Private Debt Fund ABC raising in USD, investing in AUDOUTLINE OF ATRANSACTION:01Fund ABC is a Private Debt fund denominated in USD. Fund ABC will invest USD 10M equivalent inAUD denominated debt that has a maturity of 2 years and yields 8% per annum in AUD. A decrease inthe AUDUSD currency pair will generate negative returns and possibly loss of capital if the adversecurrency variation is greater than the income from the AUD assets. At T0, the transaction inception time, the prevailing AUDUSD currency rate is 0.80. Fund ABCconverts USD 10M into AUD 12.5M and purchases for AUD 12.5M of AUD debt of 2 years maturity,yielding 8% per annum. At T0 1 Year: AUDUSD decreases 12.5% down to 0.70. ABC receives 8% AUD interest from theAUD debt. The AUD currency decrease is larger than the interest received and subsequently ABCP&L is down 5.5% in USD terms. At T0 2 Years: AUDUSD decreases 25% compared to the initial currency rate at T0 down to 0.60.ABC receives another 8% AUD interest from the AUD debt. The AUD currency decrease is largerthan the sum of interest payments received and subsequently ABC’s P&L is down 13% in USD atthe transaction maturity.Solution: Hedging the currency risk at the time T0 of the transaction inception, completely immunizesABC from currency fluctuations, and the total return of ABC at transaction maturity would be 16% inUSD which is the sum of the interest earned from the AUD debt over 2 years.Schedule of a transaction:AUDUSD prevailing rate at T0:0.80USD Investment commitment:USD10,000,000AUD Asset value:AUD12,500,000AUD Asset yield:AUD8.00%Investment maturity:Amount to hedge: capital interests2 years14,500,000

CURRENCY RISKANALYSIS:02Fund NAV P&L analysisT0T0 1 yearT0 2 yearAUDUSD prevailing currency rate:0.800.700.60Cumulated currency 2,900,00010,900,00011,600,000Portfolio of AUD AssetsAUD asset purchased at AUDUSD 0.80Cumulated Income from AUD asset 8%Total AUD Asset ValueP&L in AUDCase A: No FX HedgeFund Net Asset Value in USD AUD asset valuation expressed in USDP&L in USDCase B: With FX Futures HedgeFX hedge USD value:Sell AUDUSD Futures for 14.5MAUD @ 0.80Fund Net Asset Value in USD AUD asset expressed in USD USD hedge value P&L in USD900,0009.00%-1,600,00016.00%

FOREX CONVERSION ANDHEDGING PROGRAM:03As soon as the decision has been made to invest in AUD assets using the prevailing AUDUSD rate of0.80, there is a currency risk. In order to lock in the prevailing market currency rate, we will sellfutures at the rate of 0.80, 14.5M AUD at date T0 2 years in order to immunize the AUD assetnotional (12.5 MAUD) and the cumulated 8% interest over 2 years (2MAUD) from currencyfluctuations.AUSTRALIAN DOLLAR US DOLLARSource TradingEconomics.com

P&L RESULTS:04If the transaction is hedged, regardless of the variation of AUDUSD, the accounting result in USD atthe end of the transaction will be USD 1,600,000 corresponding exactly to the 8% per annum interestfrom the USD 10M asset investment.P&L with no hedgeP&L with ,000)(1,000,000)(1,500,000)T0 1 yearT0 2 year

Instruments & Hedging strategies to manage currency riskThere are many instruments and methods used to manage currency risk, and below we will look atthe most common including our own hedging process. Following that we have explained in a table themechanisms, the risks and the costs for each instrument and process.FUTURES AND FORWARDS: LOCK IN A CURRENCY EXCHANGE RATE TO USE AT ASET DATE IN THE FUTURE. Futures are listed on an exchange, such as Globex, that guarantees liquidityand provides valuation. Futures have no counterparty risk. Forwards are bilateral contracts with banks, they have counterparty risk, andthe bank is the valuation agent.OPTIONS: Pay an upfront premium to keep the ability to get a better FX rate up to theoption’s maturity. They can be bought directly on an exchange or bought from a bank as abilateral contract.FOREX HEDGING PROGRAM: “AUTOFOREX”Systematic hedging into domestic currency of all cash flows denominated inforeign currencies.FOREX DYNAMIC HEDGING PROCESS:Systematic currency hedging based on cash flow, taking into account thecorrelation between the assets’ performance in the portfolio and the currencies’fluctuations.FOREX OVERLAY:Specific strategy based on the fund’s decision to hedge part of its currency risk inorder to retain a currency position corresponding to the fund’s currency viewwithin its strategy objective and risk mandate.By outsourcing the management of your currency conversion and hedgingsolution to SystematicEdge, you can focus on your core business.Alain Groshens – Founder SystematicEdge

Instruments to manage currency risk: cont’dForwardwith abankFutures ontheexchangeOptionwith HedgingprocessFX OverlaystrategyGuaranteed FX rateYesYesYesYesYesYesYesYesYesYesNoNoSet usage at a specific dateYesYesYesYesYesYesYesYesYesNoNoNoNoSet usage within a specificdate rangeNoNoNoNoYesYesYesYesYesYesYesBetter FX rate could beapplied at expiryNoNoNoNoYesYesYesYesNoNoNoNoNoNoInitial premium paymentNoNoNoNoYesYesYesYesNoNoNoNoNoNoIs the contract standardizedand regulated ?NoNoYesYesNoNoYesYesn/an/an/an/an/an/a100% adverse currencyfluctuation ty n depends on n/aFX hedging service andbrokerage feesYesYesYesYesYesYesYesYesYesYesYesIntermediary execution feesYesYesNoNoYesYesNoNon/an/an/an/an/an/aFX trader bid - ask spreadexecution costYesYesNoNoYesYesNoNon/an/an/an/an/an/aHedging Instruments andprocessMECHANISM:RISKS:COSTS:

SystematicEdge Currency Risk Hedging Value PropositionCost Savings Mid market currency conversion Positive carry hedging transactions Direct Market Access (DMA) to the world’s main exchanges, bypassing intermediaries in order to minimize fees and execution costs:trades are executed at the best price on regulated exchanges. One service management fee and no execution commission (nomatter how many trades executed)Safety No counterparty risk from the hedging transaction: Hedging trades are only executed directly with exchanges in theclient’s managed account. SystematicEdge does not trade withbanks or any other counterparties. SystematicEdge does not hold client money as opposed to otherhedging solution providers. We partner with Interactive Brokers(“IB”) to open a managed account in the client’s name. Fully regulated at all levels: The client’s managed account ismaintained by IB that is regulated, trades are only transacted with theexchanges that are regulated and SystematicEdge portfolio managersare regulated. 100% STP (Straight Through Processing) with real time accountvaluation and risk management reports available and accessible via asecured internet portal: The client organization is in complete controlof its funds.Turn-key Solution Currency Risk Analysis Customized Hedging Program design, execution & follow up Service: mid market currency conversion hedging execution (best price execution) risk management