What price failure to get on top of FX risk?

From the EU extending sanctions on Russia to the rescue plan for Greece, it’s fair to say there is no shortage of events affecting a fund manager’s investment strategy. But while the situation across both regions changes daily, the goal for any fund manager remains the same: deliver absolute returns in an increasingly competitive, complex and highly regulated market.

It’s no secret that one of the keys to achieving this is managing high levels of pricing risk across FX. For many buy-side firms, murmurings of the Fed preparing to hike interest rates could lead to a bull run on the dollar. Although recent news of a delay could trigger a more bearish approach in the short term.

Certain fund managers will be aiming to diversify their positions – while keeping a large exposure to their base currency. While the relative ups and downs of currencies such as the USD, GBP and EUR are reasonably predictable most of the time, funds that manage a base currency of say the Russian Ruble, are presented with a rather more uncertain picture.

A highly volatile base currency can trigger an exorbitant amount of risk across any portfolio. Hardly what the risk manager is looking for in a climate where they need to see what’s happening so they can hedge against future risks. While risk managers may have stress testing processes in place, this won’t give them a full grasp of how their exposure is affected by the rise in currency volumes – which hit $402bn earlier this year (Source: Thomson Reuters currency platforms). Establishing accurate prices as volumes rise to better understand exposure is the challenge here, as it presents a real strain on existing operations.

To address this, certain fund managers have gone down the road of building spreadsheets and relying on more people to sift through high volumes of data. Unfortunately, when people are involved errors occur, which ultimately leads to less accurate prices. Hence the trend towards these fund managers looking for a different solution – one that not only allows a third party to cleanse data for more accurate prices, but also to manage the infrastructure. It’s easy to see why, as with pressure to reduce bottom line costs, no fund manager wants the burden of having to do all this themselves.

For fund managers with a volatile base currency, going down the same old path of relying on people intervention is too big a risk to take – particularly in a market fraught with complexity. However, for those that adopt the third party route, there are reasons for optimism during these unpredictable times. Selecting this approach should lay the platform for better fund performance which means higher revenues. In this risk-conscious world, having strong foundations is the first step on the road to delivering those all-important returns for investors.

 

Dev Bhudia is vice president of Product Management at GoldenSource

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