after annualising. Thismeans that by multiplying a log (by, say, 12), we are raising the exponentiated value to apower. This is convexity in action.If all of this is confusing, a practical example might help. Suppose we have monthly data, theSD of which we wish to annualise. Table A2.5 shows the error generated by the conventionalannualising process versus the log methodology. To read the table, take a value of column (a),Table A2.5Volatility ofVolatility ofAnnualisedmonthly seriesthe logsvols√(a)(b) = ln(1 + a) (c) = exp(b 12) − 11.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%
0.009950.0198030.0295590.0392210.048790.0582690.0676590.076961
3.51%7.10%10.78%14.55%18.41%22.37%26.41%30.55%
Annualising% Error√ vs.ratio12‘Months’√(d) = c/a(e) = (d/ 12) − 1 (f ) = d2√12 = 3.464112.003.50701.24%12.303.55032.49%12.603.59403.75%12.923.63825.02%13.243.68276.31%13.563.72777.61%13.903.77318.92%14.243.819010.24%14.58
say 4%. This is the observed monthly SD, calculated by the correct log method, converted intopercentages by the exp function. Column (b) shows the related monthly log SD, and column(c) the correctly calculated √annualised SD. The remainder of the columns show the annualisingratios and the error versus 12, with column (f) showing the ratio converted into months. Sofor an asset with a monthly SD of 4%, this translates to an annual√ SD of 14.55%, 5% [column(e)]higherthanwouldbecalculatedbyastraightfactorof12 or 3.4641. This equates to√√13.24 months rather than 12 months.This is a very radical ﬁnding, the importance of which cannot be underestimated for investment analysts, managers and consultants. As mentioned earlier, the one area where theproblem does not arise is in option-pricing models – since no exponentiation ever appears totake place, and the traders just talk in ‘logs’, i.e. ‘Latin’.The solutionUnlike many problems in investment, however, there is a simple solution. The correct methodology is available (and shown above), it is not computationally complex, and modern spreadsheetslike Excel can easily compute it. The correct methodology will completely solve all the approximation problems and errors encountered in relation to SDs. Incidentally, it also resolves Siegel’sparadox (1972), which apparently gives positive combined returns for two currency marketparticipants with opposing base currencies irrespective of the currency movement (see Box 5.3).
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To recap the solution, we take the observed return series,√ and instead of calculating a directannualised SD by taking the SD % and multiplying by 12, we take √the log(1+returns) andtake the SD of this [I’ll callitSD(ln)].WethenmultiplySD(ln)by12, and calculate the√exponential [exp(SD(ln)* 12)−1]. This is the ‘correct’ SD, expressed in % not in logs. TableA2.6 is a simpliﬁed version of Table A2.3, with the order of SD calculation clearly shown.Table A2.6(a)Period
(b)Returns
12.41%24.93%31.40%42.50%1.42%566.62%75.53%84.47%92.92%100.16%3.54%113.64%12SD monthlySD annualisedSD log expressed as %
(c)Logs[ ln(1 b)]0.0238550.0481100.0138950.0247210.0142810.0641470.0538240.0436880.0287880.0016090.0359970.0370830.0336460.11655312.36%
Setp 1 Calculatemonthly SD oflog returnsStep2 annualisemonthly SD(monthly 12)Step 3 Convert topercentages( exp(SD) 1)
RAPPENDIX 3 – AIMRREPORT
Copyright 1998, Association for Investment Management and Research. Reproducedand republished with permission from the Association for Investment Management andR ). All Rights Reserved.Research (AIMR
AIMR Benchmarks and Performance Attribution Subcommittee ReportAugust 1998The AIMR Performance Presentation Standards Implementation Committee, which sponsoredthe formation of this subcommittee, encourages the public to comment in writing on thesestandards. This report outlines guidelines concerning benchmark reporting. The subcommitteewill develop a report on performance attribution at a later date.AIMR Performance Presentation StandardsBenchmarks and Performance Attribution SubcommitteeJohn C. Stannard, CFA, ChairFrank Russell CompanyMary C. Cottrill, CFACalifornia Public Employees’Retirement System
Jeffrey P. Davis, CFAState Street Global Advisors
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James E. Hollis, III, CFAStandish, Ayer & Wood, Inc.Robert E. PruyneScudder, Stevens & Clark, Inc.
James L. KermesGlenmede Trust CompanyNeil E. Riddles, CFATempleton Global Investors, Inc.
Brian D. Singer, CFABrinson Partners, Inc.
Peter T. Willett, CFAState Street Global Advisors
Summary recommendationsThe committee’s report below examines some of the major factors involved in the choice ofa benchmark for an investment portfolio or composite. As a result of its deliberations, thecommittee recommends the following changes to the AIMR standards:13The AIMR standards should require that, where a benchmark exists, it must be included in theperformance presentation. The name of the benchmark plus any other signiﬁcant information(such as tax basis, etc.) must be disclosed. Where no benchmark exists, an explanation mustbe provided.This requirement will take effect from an effective date (e.g. 1/1/99 – to be determined bythe AIMR PPS committee). Use of benchmarks for periods prior to that effective date will berecommended but not required.According to prevailing conditions (e.g. portfolio or composite strategy, index availability)a benchmark may consist of two or more indexes chain-linked together over time.If a ﬁrm introduces a new benchmark to replace one used earlier for a certain composite, itmust disclose fully the reason for doing so (such as the recent availability of a better benchmark).
IntroductionBenchmarks are important tools to aid in the planning, implementation and review of investment policy. They clarify communication between the investment ﬁduciary and the investmentmanager and provide a point of departure for assessing return and risk.The terms ‘benchmark’ and ‘index’ are often used interchangeably. But while indexes aremost often used as benchmarks, a benchmark is essentially the starting point for evaluatingsuccess. So we might deﬁne a benchmark more generally as follows:An independent rate of return (or hurdle rate) forming an objective test of the effectiveimplementation of an investment strategy.A benchmark may take any of the following forms:1. A well recognised published index2. A tailored composite of assets (or indexes)3. A peer group (or ‘universe’) of similar funds or portfolios
13This subcommittee has stated its recommendations in general terms rather than by specifying speciﬁc changes to speciﬁc itemsin the AIMR PPS Handbook. In this regard, our goal is to state recommendations clearly enough that the implementation committeehas an unambiguous basis for making changes in the Handbook.
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What makes a good benchmark?Properly used, a benchmark should be a focal point in the relationship between the managerand the ﬁduciary body overseeing the prudent management of the assets. Thoughtful choiceof a benchmark will make the relationship between these parties more effective and enhancethe value of the investment strategy. The most effective benchmarks are:1. Representative of the asset class or mandate2. Investable (e.g. a viable investment alternative)3. Constructed in a disciplined and objective manner4. Formulated from publicly available information5. Acceptable by the manager as the neutral position6. Consistent with underlying investor status (e.g. regarding tax, time horizon, etc.)Benchmarks can be misused. Indeed choosing a bad or inappropriate benchmark can undermine the effectiveness of an investment strategy and lead to dissatisfaction between client andmanager. Most problems associated with benchmarks arise from not observing the basic rulesset out above (e.g. the manager doesn’t understand benchmark construction or the benchmarkdoesn’t match the mandate). But problems can also arise from setting multiple benchmarkswhich conﬂict with each other (e.g. outperform cash in the short term and equity in the longterm). The remainder of this appendix reviews the uses of benchmarks in certain special situations and provides guidelines for investors when using and applying the AIMR PerformancePresentation Standards.
Use of peer groups (‘universes’) as benchmarksThe process of selecting an appropriate benchmark often involves a choice between an index(or composite index) or a peer group universe of managers. Each has advantages and disadvantages. Published indexes of ‘unmanaged’ assets are the most commonly preferred andfrequently used form of benchmark, but a universe of managers may be a suitable alternativein some cases.The major advantage of using a universe as a benchmark is in situations where no widelyrecognised index of unmanaged assets exists to reﬂect the asset class or investment strategy.Examples of such situations would be real estate, private equity and venture capital. In thesesituations a collection of managed products rather than unmanaged assets often best representsthe asset class. What is often thought of as an index for real estate, private equity or venturecapital, for example, is in most cases actually a universe of managed assets or products.Universes do offer certain beneﬁts in performance comparisons. Universes representachieved results of manager portfolios which are effectively available as investment alternatives for investment ﬁduciaries (fund sponsors, etc.); they take full account of transactionsand other trading costs and they reﬂect decisions taken by investors across the board (e.g. to underweight Japan relative to the index). But as the sole benchmark for comparing performance,universes are subject to certain drawbacks. These include:1. They are not available real time, resulting in a time lag for comparison.2. There is no established oversight process for determining universe participants and whetherthe universe accurately represents the entire asset class or style of management.
280
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3. Survivor bias14 will develop over time as some managers are deleted from the universe.4. They are not replicable or investable.5. They do not permit the manager to move to a known neutral position.Style analysisStyle analysis is an increasingly popular technique used to determine portfolio exposures tovarious investment ‘styles’, e.g. large-capitalisation growth. The styles themselves are generallydescribed as passive indexes and in its broadest sense, style analysis includes the techniquesused to calculate these indexes. Typically, style indexes will break a broad market index downinto four (or more) mutually exclusive components usually deﬁned as large and small (orsmall/medium), growth and value segments. A style analysis model will then aim to quantifythe exposures of a portfolio to these four style components as expressed by the indexes (andthe underlying exposures to securities within the index universes). The basic tenet of styleanalysis is that a passive portfolio can be constructed by combining the four indexes. Therefore,a manager can be considered to add value only when performance exceeds the passivelyconstructed portfolio. Added value can be achieved by varying the index exposures over timeor by security selection within the index universes.Application of style analysis is beneﬁcial, but results of style analysers must be carefullyinterpreted. The most popular approach, developed by Sharpe,15 is a statistical technique, whichassesses the styles embedded in a portfolio based on correlation with the relevant underlyingindex. Due to the similar performance of certain indexes, style analysers can identify indexexposures where none actually exist. This is especially perplexing for global portfolios whereexposures to regional indexes show up even though no assets are actually held in the region.Also, this approach is based on data measured over a ﬁxed time horizon (say ﬁve years) andmay not be sensitive to sudden changes in style. Another method assesses the style of a portfoliobased on its underlying characteristics (e.g. P/E, yield, etc.). This approach is more sensitive tostyle changes although the model techniques must be adjusted market by market for underlyingconditions and accounting measures. Style analysis results must be analysed with due regardfor these factors.When using style indexes in performance presentations, investors should be careful to ensurethat the style index, or blend of indexes, is representative of portfolio objectives and riskconstraints. Failure to do so will lead to misleading impressions of outperformance. In thisregard, the results of style models must be carefully interpreted in the light of the strengthsand weaknesses of the analytical approach involved.Benchmarks for multi-currency portfoliosMost investors recognise that currencies have a large impact on the returns of international andglobal portfolios. There is less appreciation however for the role that currencies play in thechoice of an international or global benchmark. When selecting a multi-currency benchmark,the investor (implicitly or explicitly) makes both a decision on a set of underlying assets14Survivor bias occurs where terminated accounts drop out of the sample – hence the average or median return is biased based onthe surviving (and usually better-performing) portfolios.15William Sharpe’s article ‘Asset allocation: management style and performance measurement’ published in the Journal of PortfolioManagement (Winter 1992) presents the method now generally known as returns-based style analysis.
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and a decision on the desired level of embedded currency exposure. While AIMR here doesnot make a recommendation in favour of the unhedged or the hedged benchmark, we doregard the determination of currency exposure in the benchmark as an important ﬁduciaryresponsibility.Investors should, in addition, aim to analyse the effects of currency movements and currencydecisions separately from the underlying assets. There are three basic reasons for doing so. First,currency is a large source of return and risk, both in terms of benchmark selection and activemanagement. Second, modern performance attribution methods allow asset selection skill tobe differentiated from currency selection skill. Third, currency performance and attributionresults highlight the signiﬁcance of the choice between an unhedged, a partially hedged, or afully hedged benchmark. This section sets out some of the factors to consider when making thebenchmark decision in the context of currency management. Note that the guidelines beloware not intended to explicitly deﬁne a calculation methodology but simply highlight the factorswhich managers must be aware of when managing portfolios. Speciﬁc methodologies foranalysing currency return must be developed in the light of underlying portfolio structure andanalytical needs.Relative interest rates and the forward premiumInvestors often use the change in spot exchange rate (over a holding period) as a measure ofthe inﬂuence of currency on their portfolios (i.e. of the ‘unhedged’ currency return). However,this approach is misleading since it fails to reﬂect the actual returns that can be obtained bycurrency instruments and ignores the effect of the forward currency premium16 (referred tohereafter simply as the forward premium). In fact we get better information about the trueeffect of currency if we split the return derived from the change in spot rates into two separablecomponents:1. The forward premium which is known in advance and is driven by short-term interest ratedifferentials.172. The component of the change in spot rate not accounted for by the forward premium andwhich is commonly called the currency surprise.18The reason we identify these two components separately is that they help explain an importantfact. Investors cannot eliminate currency effects entirely and earn the local return.19 Theycan only eliminate the currency surprise component while retaining the forward premiumcomponent. Thus, the hedged return is different from the local return and is the return that theforeign investor will earn that is free of currency risk.16The forward premium can be positive (if interest rates in the foreign currency are lower than the home market) or negative, i.e.giving a forward discount (if rates abroad are higher).17The interest rate differentials are ‘short-term’ because liquidity in the forward currency market only extends to short-termcontracts, i.e. up to one year.18The notion of ‘currency surprise’ (calculated as exchange rate movement less forward premium) is one useful basis for evaluatingcurrency effects and currency decisions. Karnosky and Singer set out an alternative methodology in the ICFA Research Foundationpublication ‘Global Asset Management and Performance Attribution’. This approach also recognises the impact of relative interestrates by adjusting nominal market returns by the risk-free rate. The Karnosky and Singer methodology is consistent with the currencysurprise and forward premium framework.19The local return is the foreign asset return expressed in terms of the foreign currency. For example, a German equity portfolioowned by a US investor with a value of DEM100m at end-period 1 and DEM103.2m at end-period 2 has a local return of 3.2% forperiod 2. This return is irrespective of the spot currency movement of the Deutschmark.
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Currency Overlay
Relative interest rates have a signiﬁcant effect on currency returns, the pricing of hedginginstruments such as forward foreign exchange contracts and currency analysis. While forwardpremiums might be thought of as a ‘cost’ of hedging, it is perhaps more accurate to considerthem a ‘hedging return component’. They exist because currency-hedged returns for cash(riskless assets) are forced (by arbitrage) to be equal irrespective of the market or currency inwhich the investor holds the cash. So if you invest in a high interest rate, foreign cash marketand attempt to lock in that higher yield by hedging the currency, the forward premium willforce you to realise a loss in the currency market which is equal and opposite to the interestrate market gain.An excellent example of the currency surprise phenomenon is provided if you imaginethat you are a British pound investor reviewing the performance of the pound (£) againstthe Deutschmark (DM) from 1972 to 1997. Commentators often claim that the pound wasweak over this period since £100 converted into DM in 1972 would have been worth £253at the end of 1997 purely through the pound’s spot depreciation. But in fact if the investorhad sold DM forward for pounds, the total investment would be worth £340. This is becausethe cumulative forward premium (based on the relative interest rates between the UK andGermany) was greater than the pound’s actual depreciation. In fact, the currency surprise ofthe Deutschmark was negative by £87, and the hedged return outperformed the unhedgedreturn.20Accordingly, in choosing a benchmark, investors should recognise the shortcomings of usingthe spot-to-spot exchange rate difference. In particular, they should note the existence of the forward premium and, where appropriate, separate the spot movement into its two components –the forward premium and the currency surprise. In practical terms, this means don’t usespot-to-spot exchange rates as the basis for evaluating the success or impact of currencydecisions.Unhedged benchmarks versus hedged benchmarksUnhedged benchmarks, such as the MSCI EAFE Index, are those where no adjustments aremade for hedging positions. The unhedged return for each country in the benchmark consists of the combined effect of the local asset market return and the spot currency return.The benchmark therefore contains a currency component comprising both currency surpriseand forward premium. Unhedged benchmarks are used when the investment mandate doesnot include a consistent hedged position although currency activity may be allowed as ameans of adding to return and/or reducing risk. They might be used for example by investorswith relatively low allocations to foreign assets and/or investors who actively desire currencyexposure.20
This example can be expressed algebraically as follows:Change in spot rate return (c) = Forward premium ( f ) + Currency surprise (s)Hedged return (h) = Unhedged return (r ) − Currency surprise (s)
In this example, c = 153%, f = 240% and s = −87% (i.e. c = f + s). Since the Deutschmark value of the converted £100 doesn’tchange (i.e. local return = 0), we have:Unhedged return (r ) = Change in spot rate return (c)h = r − s = 153% − (−87%) = 240%That is, the hedged return effectively outperforms the unhedged return.
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283
When the neutral position for an investment strategy involves the strategic hedging of someor all of the currency exposure, then a hedged benchmark (or index) is used. Such benchmarksmay eliminate all currency exposure (a fully hedged benchmark) or they may eliminate a ﬁxedproportion (between 0% and 100%) of the currency exposure. The proportion chosen is oftencalled the benchmark hedge ratio. The return for each country in the fully hedged benchmarkconsists of the sum of the local asset market return and the currency premium. The currencysurprise component of the spot currency return is eliminated.Once again a manager can use active currency strategies to seek additional return but theneutral position is to hold hedges equal to the benchmark hedge ratio. Hedged benchmarksmight be used for example by investors with material allocations to foreign assets who wishto eliminate the volatility of foreign currencies.Benchmarking currency overlayBroadly speaking a currency overlay strategy is one in which the management of currencyis carried out separately from the remainder of the portfolio – even though it may be carried out by a single manager or within a single organisation. Currency overlay is generallylinked to the management of currency exposure within the portfolio – if a fund employsa currency manager but has no foreign currency assets this is not thought of as currencyoverlay.Currency overlay assignments can either be active or passive. Passive currency overlayversus an unhedged benchmark means neutralising the currency effect (or more speciﬁcallycurrency surprise) implicit in the active country position while (fully) hedged passive overlaymeans eliminating (all) currency surprise. Active currency overlay strategies seek to participatein upside currency gain while protecting against downside currency losses.Note in particular that, because the forward premium cannot be hedged away, hedging anasset will give you the hedged return (local plus premium) not the local return. This relationshipis fundamental to the understanding of such strategies. Accordingly, the possible componentsof currency overlay assignment might be broken down into:(A) Hedged asset return21(B) Currency surprise22(C) Overlay return23
the hedged return on the assets comprising the underlyingportfoliothe asset-weighted currency surprise component by marketthe effect of the overlay strategy (i.e. active and/orpassive positions) arising from the negative of the currencysurprise
Such strategies can also either be fully or partially hedged (i.e. the benchmark hedge ratiocan vary between 0% and 100%). These breakdowns are not signiﬁcant in themselves otherthan that they enable us to distinguish between different components of the strategy and deﬁnebenchmarks accordingly.The aim in selecting an appropriate currency overlay benchmark is that it must reﬂect thenature of the assignment. Since currency overlay is typically managed separately from the21
The sum of the local market forward premium and the local asset return.Commonly referred to as the implicit currency component.23Commonly referred to as the explicit currency component.22
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Table A3.1Description of benchmark return*Benchmark deﬁnition
Unhedged benchmark
Fully hedged benchmark
Asset + currency + overlay(A + B + C)
Hedged asset return + currencysurprise (=local asset return +spot return)Currency surpriseNil
Hedged asset return (=localasset return + forward premium)
Currency + overlay (B + C)Overlay only (C)
NilNegative currency surprise
* Partially hedged benchmark structures can be constructed as the weighted sum of unhedged and fully hedgedbenchmarks shown above (e.g. 50% hedged currency + overlay is 50% of currency surprise).
underlying foreign assets, performance should be correctly attributed by portfolio or managerand it is important to identify which components of the assignments are the direct responsibilityof the currency overlay manager. The benchmark can be legitimately expressed either as theasset + currency + overlay return [(A) + (B) + (C)], as the currency + overlay return [(B) +(C)], or as the overlay return [(C)] only.Some examples of possible benchmark speciﬁcations are shown in Table A3.1. An investorshould deﬁne a consistent currency overlay benchmark based on the strategic considerationsof the fund. These considerations will include: the maturity of the fund, the size of its international asset allocation and the fund’s risk/return trade-off. The structure of the benchmarkwill depend on the nature of the assignment and the component of the overall strategy to bemeasured.Other practical considerationsThe following further factors must also be considered when designing currency overlay benchmarks:1. The portion of the underlying assets that will form the basis for calculating the currencyoverlay return – all foreign assets, or just those for which currency hedging is practicableat reasonable cost.2. The treatment of deviations from benchmark currency weights in the underlying portfolio.3. Treatment of issues such as mid versus bid/offer pricing of contracts and treatment ofilliquid currencies should be considered and where necessary treatment should be consistentbetween the portfolio and the benchmark.4. The ﬂow of information on the allocation of the assets being overlaid and the practicalfrequency for rebalancing back to benchmark – in practice, weekly or monthly rebalancingis probably more practical than daily.One-way ticket effectThe one-way ticket effect describes the fact that a currency overlay manager with an unhedgedbenchmark can only beneﬁt from hedging a currency when that currency is weak. Conversely,a currency overlay manager with a fully hedged benchmark can only beneﬁt from ‘lifting’hedges when the currency is strong. This leads to an asymmetrical, ‘one-way ticket’ inﬂuence on returns for currency portfolios. Investors should recognise that periods of continuous
Appendices
285
‘one-way’ currency movement can last for very long periods, so performance targets for shorterperiods should take this into account.Partially hedged benchmarks reduce this problem, and a benchmark hedge ratio of 50% eliminates it. However, where strategic considerations make setting a partially hedged benchmarkundesirable, alternatives include setting differential currency performance targets in periodsof base currency weakness or strength or, probably a better course of action, allowing the currency cycle to run its course. Alternatively, an investor might set a band for currency allocationaround the benchmark position, e.g. plus or minus 20% of the benchmark weight. Since, for anon-domestic currency assignment, this may give rise to a foreign currency exposure of morethan 100% of the portfolio,24 this decision must be taken with due consideration for the riskparameters of the portfolio, and any legal or other limitations.
APPENDIX 4 – SAMPLE INVESTMENT GUIDELINESGeneral remarks[CURRENCY MANAGER] will be responsible for the execution of a currency overlay programme for [INVESTOR] ‘the Client’ as follows:[CURRENCY MANAGER] will actively manage the currency overlay on the Client’s international investment portfolio comprised of [equities] [bonds] [property] [cash].
Benchmark[CURRENCY MANAGER]’s performance will be measured against an [unhedged] [50%hedged] [fully hedged] currency benchmark. See [Annex] for a description of the performancebenchmark calculation. The overlay programme benchmark is determined by the Client andcan be modiﬁed or adjusted by the Client upon written notice to [CURRENCY MANAGER].
Mandate sizeThe initial mandate size is equal to the whole of the Client’s international equity portfolio asreported to [CURRENCY MANAGER] by the Custodian (see below). The Client may varythis mandate size at any time by giving written notice to [CURRENCY MANAGER].
Return and risk objectives[CURRENCY MANAGER] should achieve an outperformance on the currency overlay programme against the benchmark’s performance of [1%] p.a. net of all costs and fees over amarket cycle of 3 to 5 years. A detailed description of the performance calculation is providedin the [Annex – Calculation Methodology].[CURRENCY MANAGER] should achieve the return objective with a target tracking errorof [2.5%]. The tracking error is the annualised standard deviation of the monthly outperformance of the overlay programme versus the benchmark.
24
Or less than zero for a fully hedged benchmark.
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Currency Overlay
Eligible currencies[CURRENCY MANAGER] may only undertake spot and forward currency exchange contractsin currencies that are part of the currency overlay programme as speciﬁed below.The actively managed overlay programme will only be implemented in the following currencies: [US dollar, Japanese yen, euro, Swiss franc, Swedish krona, Australian dollar, Canadiandollar, Hong Kong dollar, Singapore dollar]. [CURRENCY MANAGER] may, at its discretion,decline to enter into hedges in any of the above currencies if either the portfolio exposure inthat currency falls below a tradeable market amount, or if lack of liquidity in the market forforward currency contracts adversely affects the performance of the overlay.[CURRENCY MANAGER] may elect to hedge a less liquid currency exposure (whether ornot included in the above list) by entering into forward contracts in a proxy currency (whichwill be in the list above). Any proxy hedging will be approved in writing by the Client prior totrading, and the list of proxies may be changed only with the written approval of the Client. Anexample of a proxy might be to undertake US dollar contracts to hedge a Hong Kong exposure.Proxy hedging will not be undertaken tactically – only as a strategic decision to minimise thecosts of transactions.The currency composition of the active overlay programme will be designed by [CURRENCY MANAGER] and must be communicated to and agreed in advance with Client.Without the consent of the Client, [CURRENCY MANAGER] may not make any changes tothe currencies that are part of the overlay programme.Investment restrictions[CURRENCY MANAGER] may only enter into forward contracts such that the hedge ratio(the foreign currency amount of the net outstanding sales of the forward currency divided bythe portfolio asset value denominated in that currency) does not lie outside the range [−3%]and [103%].Counterparties[CURRENCY MANAGER] may only enter into transactions with counterparties that havelong-term senior debt or unsecured claims paying ability rated at least [Aa3 by Moody’s] andhave ratings for short-term instruments of [P1] (or the equivalent ratings from other ratingsources), and with the prior written approval of the Client.The creditworthiness of all counterparties must be monitored by [CURRENCY MANAGER]on an ongoing basis. [CURRENCY MANAGER] should take all reasonable steps to protectthe Client’s assets in the event of adverse changes to a counterparty’s creditworthiness. It isacknowledged that it is [CURRENCY MANAGER]’s practice to remove a downgraded Bank(which falls below the permitted minimum) from the active dealing list, but to allow forwardcontracts to run off without premature close-out or accelerated settlement.RebalancingThe rebalancing of the overlay programme will take place on a monthly basis