Assess client requirements,
define the target structure.
The following 7orca FX Consulting case study presents an anonymised client case involving an institutional pension provider with an investment portfolio in the low double-digit billion range – comparable to many pension schemes, pension funds and insurers – as well as a broad multi asset portfolio and diverse foreign currency positions.
Initial situation:
foreign currency risks without a robust reference benchmark.
An institutional pension provider with an investment portfolio in the low double-digit billion range invested across a broad spectrum of asset classes: direct fixed-income holdings, credit strategies, equities, real estate, private equity and other alternative investments.
A significant proportion of the positions was invested in foreign currencies. The resulting FX Exposure arose for different reasons: in some cases as a deliberate source of diversification, in others as a by-product of the underlying investment decision.
The central challenge was the absence of a robust FX Benchmark against which the existing hedging approach could be aligned or assessed. Decisions regarding hedge ratios had evolved historically or were based on broad assumptions or intuition, making them difficult to substantiate comprehensively to the management board, investment committee and supervisory bodies.
7orca approach: FX Benchmark workshop with quantitative analysis.
7orca conducted a structured FX Benchmark workshop with the client. The analysis focused on objectives, risk budget, regulatory requirements, governance requirements and the role that foreign currency risks should assume within the overall portfolio.
The analysis assessed a range of benchmark approaches.
- Fully unhedged benchmark
- Naive 50/50 benchmark
- Fully hedged benchmark
- SAA-based benchmark methodology
The analysis focused on a benchmark methodology based on strategic asset allocation. Using Monte Carlo-based methods, 7orca simulated numerous portfolio configurations and derived a risk–return profile for the overall portfolio depending on the respective hedging level for each currency.
A key reference point was the minimum variance portfolio: the hedging level for each currency that minimises the overall portfolio risk on a quantitative basis.
Efficiency assessment of the existing hedging structure.
The client’s existing hedging approach was also positioned within the same risk–return framework. This made it possible to determine whether the existing structure was already close to an efficient solution or whether unused optimisation potential remained.
The comparison with the minimum variance portfolio and the Sharpe optimum provided a robust basis for determining the range of economically appropriate hedge ratios for each currency.
Client benefit: benchmark, governance and repeatability.
At the end of the workshop, the client had a quantitatively derived FX Benchmark aligned with its portfolio structure, risk-bearing capacity and governance requirements.
The benchmark can be used in two ways.
- As a direct basis for the passive implementation of the hedging approach
- As a reference benchmark for the objective assessment of active FX or asset managers
At the same time, the analysis established a robust basis for decision-making by the management board, investment committee and supervisory bodies. Decisions regarding hedge ratios can therefore be methodologically substantiated and documented and can be updated in response to changing market conditions, asset allocations or risk budgets.
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Sven O. Müller
Head of Relationship Management
| Telephone: | +49 40 33 460 4613 |
| Email: | sven.mueller@7orca.com |