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Analysing different Share Classes for CISs

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Any investment professional, particularly those directly involved in working within the Funds industry as well as those people whose investment portfolio consists of some allocation, in any shape or form to funds, foreign Funds in particular but also local Funds, will note that, we have been witnessing a strong trend over the past ten years or so by global asset management companies to launch and offer Sub-Funds having an array of share classes. There could be various reasons why to launch more than one share class, but they could be either income accumulating (accumulator) or income distributing (distributor); Institutional or Retail Share Classes. Those are the most popular – however, we have seen a marked increase in the issuance of hedged classes as opposed to the traditional Unhedged Share Classes.

It is very common practice for the performance of a share class within a sub fund to be reported in a series of currencies in which that specific Share Class is launched, as each investor will choose to invest in those share classes which suit their needs, similar to the ones mentioned above.

Putting things into context – say an investor whose day-to-day income and expenditure is more often than not in euros, we can assume that the client has euro as his/her base currency. However, the investor might be invested in an Emerging Market Bond Fund having a Share Class in EUR rather than in the USD share class. By doing so, the investor would be willing to take on the market risk of investing in US securities or USD denominated Emerging Market securities, but wishes his/her portfolio of investments to be EUR based, the base currency. In such cases, investors who choose a currency other than that of the fund‘s investment strategy do so at the expense/risk of having their investment returns influenced by exchange rate movements between the currency of the fund’s investment strategy and the currency of the share class.

Asset managers have a number of tools and investment strategies at their disposal to mitigate this currency risk, and that is by primarily entering into transactions known as currency hedges. By doing so, asset managers will be minimising the impact of these exchange rate movements. Ultimately, this serves to remove but not completely eliminate some of the currency-related risks, thereby permitting an investor to be exposed to the performance of the underlying assets, without the additional risk of being exposed to unnecessary/unwarranted currency fluctuations.

It must be said and pointed out that no hedging strategy is 100% perfect and therefore currency risk can never be eliminated in its entirety. There are differences primarily relating to costs, the type of instruments used, amongst other things. This means that a USD Share Class and a Hedged EUR share class (hedged at share class level) will move practically in tandem, in the absence of any cost-related adjustments. Having said that, the return an investor will be exposed to is a mix of the performance of the underlying asset/constituents of the fund, as well as the impact of any currency movements at fund level.

Hedged and unhedged share classes are created by fund managers and asset management companies to give investors that extra flexibility in their investment choices. All in all, each investor will look at his/her individual circumstances to determine which type of share class to invest in. In addition, the ongoing expenses between hedged and unhedged share classes should be more or less identical, with the hedged share classes being that little bit more expensive as the NAV will have the embedded hedging costs, but that is more than understandable, as the ultimate goal of eliminating currency risk comes at a cost.

From an asset management perspective, the process of hedging at share class level has no impact whatsoever on the management of underlying assets in the sub-funds offering NAV hedged share classes because it is the NAV of the relevant share class which is hedged, and therefore not the underlying assets of the Sub Fund as a whole. This means that portfolio Hedged Share Classes are hence targeted at reducing underlying currency exposure, and will therefore generate varying levels of performance to the sub-fund’s unhedged share classes brought about by the different currency hedge positions.

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