Private equity/alternativesActive overlay
Domesticequities
Internationalequities
Passivecurrencyoverlay
Bonds
Privateequity
0.6−0.10.20.3−0.1
−0.50.10.4−0.4
0.0−0.20.8
0.10.0
−0.1
need his mathematics,22 just the principles. In the following optimisation, I use an iterativenumerical solution (that is, trial and error) with many iterations to ‘home in’ on the optimumsolution23 .Box 5.6
Modern portfolio theory
The father of modern portfolio theory, as it is now retrospectively called, is Harry Markowitz.Markowitz was a young mathematical economist in Chicago in the 1950s, and wrote a paperin 1952 (‘Portfolio selection’, op. cit.) in which he set out for the ﬁrst time the mathematicsof portfolio risk and return – deﬁning the concept of portfolio optimisation. Markowitz’sinnovation was to show how, with three pieces of information about each component ofthe portfolio (expected return, expected volatility and correlation with other assets/stocks),an ‘efﬁcient frontier’ of portfolios could be constructed for which, at each level of return,risk was minimised, and at each level of risk, return was maximised. This process waschristened ‘portfolio optimisation’.The next innovation was the introduction of the concept of the risk-free asset. A risk-freeasset in this context is, contrary to popular opinion, not a monetary asset with nil probabilityof default; it is rather an asset with zero volatility of return (and hence zero correlationwith any other equity). Sharpe showed that adding the possibility of a risk-free asset to aportfolio could only improve its performance. He also derived the counterintuitive ﬁnding(under the ‘classical’ assumptions of these theories) that one optimal asset mix prevailedwhatever the investor’s risk/return preferences, the only variation being the extent of riskfree asset/borrowing. This led to the concept of the Capital Market Line, the efﬁcient (andlinear) risk/return trade-off.To round up this group of theories, the Capital Asset Pricing Model extends this conceptto a valuation model for individual securities. This establishes the individual security equivalent of the Capital Market Line – the Security Market Line. This is the (linear) relationshipbetween the expected return of a security and its covariance with the market’s returns. Astock’s beta (covariance between stock and market/market variance) is, under this theory,the sole determinant of its expected return.Although all three of these theories only hold under assumptions that are violated inpractice, nevertheless they form a framework for quantitative analysis which has endured.2223
Markowitz optimisation maths is still widely used, but it is not the only method available.Microsoft Excel does this very efﬁciently for us using an add-in called ‘Solver’.
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Currency Overlay
The constraints I apply to the ﬁrst result are that no asset class can have negative allocation(i.e. no borrowing), no asset can have more than 100% of the assets, private equity/alternativeshas a maximum allocation of 10%, and neither of the currency overlays uses up any capital(i.e. they do not require any initial capital allocation), nor can they have a combined hedgeratio on international equities of greater than 100%.The results of running this optimiser are shown in Table 5.6, with maximum portfoliovolatilities as shown in the columns (5%–15%). In this case, the optimiser favours internationalequities over domestic for two reasons:Table 5.6 Asset allocation from optimiser (active overlay permitted)Maximum relative portfolio volatility% of portfolio
5.0%
7.5%
10.0%
12.5%
15.0%
Domestic equitiesInternational equitiesPassive currency overlayBondsPrivate equity/alternativesActive overlay‘Optimised’ relativeportfolio return
0.0%26.9%0.0%68.4%4.7%26.9%
1.7%40.3%0.0%50.5%7.5%40.3%
3.0%53.6%0.0%33.4%10.0%53.6%
4.8%70.1%0.0%15.1%10.0%70.1%
0.0%90.0%0.0%0.0%10.0%73.9%
0.97%
1.52%
2.03%
2.52%
2.85%
(a) The assumption that their volatility is the same (both 16%) hides the fact that the currencyhedged volatility of the international equities is lower than domestic (this is borne out inthe historical data in all cases except the US as base currency).(b) Active currency overlay adds value, but can only be overlaid on international assets underthe constraints of this optimiser. Hence the optimiser boosts the proportion of internationalto catch the overlay added value.Active overlay is strongly negatively correlated with international, but much less negativelycorrelated with domestic (as is in fact the case). The strong negative correlation with international is always true – the currency exposure inherent in unhedged international being offset bythe ‘negative’ currency exposure in overlay. Active is preferred in the optimiser over passivebecause it is almost as negatively correlated with international equities as passive is (about 0.1less, again borne out in the historical data), but yields value added.If we do not allow active currency overlay (which might be the case for an investor whois not convinced there is active value added available in the currency markets), and re-run theoptimiser with otherwise the same assumptions, we get the results in Table 5.7. This portfoliocannot get more than 2.30% excess return, irrespective of volatility, given the constraintsimposed. The 15% volatility column is a volatility constraint that is not biting. The mix betweendomestic and international equities is therefore random, as is the currency overlay proportion.We can impose transaction costs on passive hedging, keeping active currency overlay prohibited. For this exercise, I will use passive costs of 0.20% p.a. – a cost level provision that isvery generous in my experience (see Chapter 6 for more details). Table 5.8 shows the results.Again, in the 15% volatility column, the volatility constraint is not biting. This means that
Theory of Currency Hedging of International Portfolios
101
Table 5.7 Asset Allocation from optimiser (active overlay prohibited)Maximum relative portfolio volatility
Domestic equitiesInternational equitiesPassive currency overlayBondsPrivate equity/alternatives‘Optimised’ relativeportfolio return
5.0%
7.5%
10.0%
12.5%
15.0%
6.3%18.5%18.5%68.1%7.1%
12.1%29.4%29.4%48.5%10.0%
19.5%43.2%43.2%27.3%10.0%
26.5%56.0%56.0%7.5%10.0%
22.2%67.8%1.4%0.0%10.0%
0.85%
1.33%
1.75%
2.15%
2.30%
Table 5.8 Asset Allocation from optimiser (active overlay prohibited, passive costs0.2%)Maximum relative portfolio volatility
Domestic equitiesInternational equitiesPassive currency overlayBondsPrivateequity/alternatives‘Optimised’ relativeportfolio return
5.0%
7.5%
10.0%
12.5%
15.0%
0.0%21.5%17.0%70.4%
16.0%25.0%20.3%49.0%
24.3%37.7%27.7%28.1%
32.3%49.2%34.7%8.5%
71.6%18.4%0.0%0.0%
8.1%
10.0%
10.0%
10.0%
10.0%
0.80%
1.28%
1.68%
2.06%
2.30%
passive overlay is abandoned, since its risk-reducing appeal (which in this case is its only appeal) is lost. At the lower volatility constraints, the optimised hedge ratio varies between 70%and 81%. This illustrates that even where there is performance drag from passive overlay, theoptimiser regards this as a price worth paying to get the beneﬁt of the risk-reducing properties(i.e. negative correlation) of currency overlay.
5.4 IMPLICATIONS OF TRANSACTIONS COSTSWe can extend this analysis on the impact of passive overlay transaction costs. In Chapter6 we will examine in detail how passive overlay costs arise, in which categories, and estimate their likely averages and ranges. However, the result can be expressed in summary asa performance ‘drag’ on the passive overlay assumption of zero expected return. Keeping allthe other assumptions intact, we can vary the annual costs of passive overlay assumed withinthe optimiser. In Figure 5.4, I show the result of this exercise for three of the lower portfoliovolatilities (5–10% volatility), and graph the hedge ratio versus the cost.We can see from this graph that the optimiser remains keen to include a proportion of passiveoverlay even at very high annual cost drags. How can the optimiser want to include an overlay(which does not displace any other asset class) if it is such a drag on performance? In summary,the optimiser seeks to maximise return subject to the portfolio risk constraint (and any other
102
Currency Overlay120.0%
Optimised hedge ratio
100.0%
80.0%
60.0%
40.0%5% Portfolio volatility constraint7.5% Portfolio volatility constraint20.0%
10% Portfolio volatility constraint
0.0%0.00%
0.10%
0.20%
0.30%
0.40%
0.50%
0.60%
Passive overlay cost % p.a.
Figure 5.4 Optimised hedge ratio versus passive costs (5%, 7.5% and 10% portfolio volatilityconstraints)
constraints we have imposed). Equities are the core strategic ‘added value’ asset, and theoptimiser will seek to add these with as little additional risk as possible. Hedged internationalequities are lower risk than domestic equities, and even though (with positive passive costs)hedged international equities will have lower return than domestic equities, they neverthelessremain the most efﬁcient way of adding expected return within the constraints.Portfolios with lower volatility constraints will pay a higher return premium than those withhigher volatility constraints, hence the higher passive costs the portfolio will tolerate beforethe passive overlay is reduced. Once the volatility constraint is eliminated (as is the case with the15% volatility portfolio), passive overlay becomes irrelevant, and will not be included in theoptimiser even if the passive costs are zero. (Strictly speaking, the optimiser is indifferent tooverlay under these conditions, so the hedge ratio is indeterminate.)5.4.1 Expected portfolio added value from passive hedgingWhile the curve in Figure 5.4 looks quite smooth and well-deﬁned, at high levels of overlaycost, and low volatility constraints, the hedge ratio becomes relatively immaterial, that is it doesnot affect expected portfolio returns very much. Similarly with high volatility constraints – inthis case passive overlay will be ignored.How can we get a feel for the improvement in a portfolio’s return given a ﬁxed level ofportfolio risk? And how does changing that ﬁxed level affect the expected value added? InFigure 5.5, I have run the optimiser at each risk level to show the difference in expected annualportfolio return of optimally hedged versus unhedged. I assume a passive cost of 0.1% p.a. –a level of passive costs which has been achieved in practice.The ‘random’ variations in the curve are the result of the ‘coarse’ nature of the optimisation,and the small numbers involved. While the absolute values of the value added might appear
Theory of Currency Hedging of International Portfolios
103
Portfolio value added % p.a.
0.10%
0.08%
0.06%
0.04%
0.02%
0.00%0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
Portfolio volatility constraint
Figure 5.5 Optimum portfolio value added from passive hedging (0.1% p.a. hedging costs, 2% equityrisk premium)0.16%
Portfolio value added % p.a.
0.14%0.12%0.10%0.08%0.06%0.04%0.02%0.00%0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
Portfolio volatility constraint
Figure 5.6 Optimum portfolio value added from including international (2% equity risk premium,equal volatilities for domestic and international equities)
quite small, nevertheless we are measuring the effect of passive hedging at portfolio level,while the proportion of the portfolio that overlay covers (i.e. international equities) might be,say, in the high 30%s. This means that a passive overlay that costs 0.1% p.a. might generate agross 0.30% or so in effective value added through risk reduction and asset reallocation. Where
104
Currency Overlay
do I get the 0.30% from? The allocation to international equities for a 10% portfolio volatilityis 40%. The ‘added value’ of the passive overlay is therefore 2.5 times larger when expressedas a percentage of international rather than the whole portfolio (=0.23% = 0.09%/40%). Thepassive overlay has an (assumed) cost associated with it of 0.1%, hence the gross ‘value added’of passive of 0.33%.Finally, to put in context the effect of other asset allocation changes at portfolio level,Figure 5.6 shows the value added from releasing a ‘no-international’ rule. That is, I have runthe optimiser (with no overlay of any kind) with and without international equities. The ‘valueadded’ from allowing international equities in the optimiser is as shown, and illustrates thata quite fundamental asset allocation change – that of prohibiting international equities in theportfolio – only affects the optimised returns by up to 0.15% p.a. At a 10% portfolio volatilityrestriction (a ‘normal’ risk portfolio with some 28% bonds), disallowing passive hedging isas expensive as disallowing international equities completely. This makes passive hedging astrategic decision in the same order of magnitude of importance as the international allocationdecision.
6Passive Currency OverlayIn the preceding chapter we saw that passive currency overlay produces a stream of returns(which I have called ‘contribution from hedging’). We saw that this stream is always negativelycorrelated with international equities, has an expected return of zero, and does not employ anycapital (i.e. does not use up any asset allocation in the 100% available). This chapter investigatesexactly how this stream of returns is generated, and the consequences of passive hedging onthe structure and returns on the portfolio.
6.1 MECHANICSLet us start with the mechanics of passive hedging. A fund with a base currency of US dollarshas an international portfolio invested abroad. For the purposes of this example (Table 6.1)it does not matter whether the assets are equities, ﬁxed income or any other asset capable ofregular valuation. Suppose the asset mix is as shown. This is a not untypical mix of assetsTable 6.1 Example asset mixCountry/currencyblocUKJapanEuroSwitzerlandOtherTotal
Asset value (foreigncurrency)
Spot rate (foreigncurrency per dollar)
Assetvalue (USD)
Proportion ofinternational
20.0024.0035.007.00
0.6250120.001.00001.4000
32.0020.0035.005.008.00100.00
32.0%20.0%35.0%5.0%8.0%100.0%
from a currency perspective. What does an overlay (or investment) manager do when asked toprovide, say, a 100% passive hedge for this portfolio?Let us suppose that the benchmark is one month, and that the fund is seeking a 25 bp p.a.tracking error limit. This will prompt a number of decisions from the overlay manager. Thedetailed reasoning behind these decisions need not be the concern of the reader yet. We willdiscuss these in more detail later, and in Chapter 7. A summary list of decisions is shown inTable 6.2. I will take each of these in turn, grouping related decisions where relevant.6.1.1 Original maturity of forward contractsThis is one of the key decisions to be taken. The default position of an overlay manager is touse a maturity of contracts that matches the benchmark, since otherwise tracking error betweenthe actual portfolio and the benchmark will be created for no expected return. Most publishedhedged benchmarks use one-month original maturity contracts, and so one-month contracts inthe portfolio are common. Maturities of less than one month are rare.
106
Currency Overlay
Table 6.2 Passive overlay decision listDecision to be made
Manager’s choice
Original maturity of forward contractsFrequency of cash ﬂowsCurrencies to be hedgedBenchmark or actual asset weights to be hedged?Denominator of ‘contribution from hedging’Frequency of asset valuationFrequency of rebalancingRebalancing buffer (Y/N? Size)Delay in rebalancingInstantaneous absolute hedge ratio limitation?Valuation rates
1 monthMonthlyGBP, JPY, EUR, CHF, AUD, SEK, HKDBenchmarkAll international assetsMonthlyMonthlyYes – 1% of total overlay size4 working daysNoReuters/WM London Close
As an aside, why do I use the expression ‘original maturity’. The answer is because hedging contracts are only one-month maturity on the day they are initiated. They naturally decline in maturity with the passage of the month, and their average maturity is therefore twoweeks.What might lead an overlay manager to adopt a contract maturity different from the benchmark maturity? There are several possible reasons:1. He may determine that the overlay transactions costs over time are lower with an originalmaturity other than one month.2. One-month maturities will produce cash ﬂows of at least once a month – this may be toofrequent for the fund, and/or create too much short-term volatility of cash ﬂows.3. If the benchmark maturity is long (which is not the case in this example), the overlay managermay choose to hedge at shorter maturities to get better liquidity. (It could be argued thatliquidity is a subset of a costs argument, but on occasion it may not directly be costs butability to execute that is the key.)6.1.2 Frequency of cash ﬂowsIt may appear at ﬁrst glance that this is the same as the ﬁrst question. However, forwardcontracts do not necessarily have the same ‘roll-over’ dates – they could be staggered forsmaller ‘tranches’ of each currency, or by currency. In the above example, there could bematurities every week or every fortnight, creating twice or four times as many cash ﬂows.This choice may be occasioned by practical needs (resources required to undertake roll-overdeals), by risk-reduction arguments (reducing the impact of one roll-over price), or by a desireto reduce or smooth the impact of cash ﬂows.6.1.3 Currencies to be hedgedThis is always an awkward problem whose solution is always a compromise. Almost allinternational portfolios have a small proportion of their assets held in currencies that arenot easily or cheaply hedgeable, or indeed not hedgeable at all (see Box 6.2). In our sample portfolio, we are (typically) given an ‘other’ category which is 8% of the portfolio by
Passive Currency Overlay
Box 6.1
107
Tracking Error
Currency overlay managers, like all active managers, can be measured according to relativeperformance versus a benchmark return. If actual portfolio returns and benchmark returnsare recorded (say monthly), the difference between the two series will produce a monthlyseries of relative returns. These relative returns will have measurable characteristics – astandard deviation (or relative volatility) and average return. When annualised, the standarddeviation is called ‘tracking error’ and the average return is the manager’s value added or‘alpha’.Tracking error is a measure of the deviations of the manager’s return from the ‘neutral’benchmark position. It is a measure of the actual risk that the manager has taken relativeto the benchmark. In overlay mandates, tracking error is often speciﬁed in the manager’sinvestment guidelines. This allows the client a further means of checking that the manageris operating his process in the way agreed prior to the start, and at a level of risk that isacceptable to the client.Currency overlay has some active management styles which are designed to be asymmetric in their return patterns. These styles, especially if they are being implemented effectively,can lead the tracking error to be wider than desired, but only on the upside – i.e. when addedvalue is positive. This has led to alternative tracking error measures (particularly ‘downsideonly’ standard deviation) being considered for this type of mandate. Despite the obviousappeal in not penalising a manager when performance is good, nevertheless most trackingerror tests have remained as a simple standard deviation.value. In the example I have assumed that a proportion of this 8% is in Australian dollar andHong Kong dollar, but that there are a number of other currencies (Taiwanese dollar, Koreanwon, Malaysian ringgitt to name a few) which are not practicably hedgeable at reasonable cost.What to do with these currencies, when the benchmark is hedged?It is worth examining the detail of the construction of the benchmark before making adecision, but generally it is simply not cost-effective to include these and similar currencies ina hedging programme.Most overlay managers will adopt a pragmatic stance towards this question. They mayproxy hedge (see Box 6.3) if the correlations with another currency are thought good enough(e.g. proxy hedge the Hong Kong dollar with the US dollar for a UK, euro or Japanese basecurrency), but generally they will simply leave the exposure unhedged. If a manager leaves acurrency unhedged, it will create an unrewarded tracking error versus the benchmark. However,it is reasonably arguable that the benchmark is uninvestible if the minor currencies, assumedby the benchmark to be investible, in fact are not.This leads many managers to request that their benchmark only include hedgeable currencies,and that benchmark performance is calculated only including these currencies, and using onlyassets invested in hedgeable currencies as the denominator. This eliminates spurious trackingerror, but it also means that the benchmark becomes custom, rather than published. Many fundclients ﬁnd this awkward, and will resist pressure to adopt this route. In practice, my experienceis that most mainstream (pension fund) portfolios have less than 10% of their assets investedin unhedgeable currencies. For many it will be less than 5%. This means that the materialityof this question can be quite small in relation to other sources of tracking error and otherissues.
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Currency Overlay
Box 6.2
Tradeable currency
In the context of currency overlay, a tradeable currency is a matter of opinion, rather thanfact. The key requirement for a currency overlay manager is to deal in currencies which donot undermine the rationale for the overlay. This essentially means dealing at low transactioncosts.The key criteria for a currency to be tradeable could therefore be characterised as follows:
r No exchange controls preventing purchase or saler A well-developed spot marketr A well-developed forward marketr Adequate liquidity (ability to trade at least $10m a time)r Acceptable bid/offer spreads (say <0.20% for outright forwards in active overlay;<0.50% for outright forwards in passive overlay)
One further criterion is sometimes applied to very weak/high interest rate currencies inpassive overlay. That is, the interest differential with the home currency has to be ≤10% forthe currency to be ‘tradeable’. Very high levels of anticipated depreciation (which hedginglocks in) begin to undermine the rationale for hedging – spot depreciation is not eliminatedby such hedging, it is merely delayed.At 30 September 2002, the following 19 currencies satisﬁed the active and passive criteriarespectively, and 152 currencies did not:ActiveHong Kong dollarEuroJapanese yenBritish poundSwiss francSingapore dollarCanadian dollarUS dollar
UAE dirhamDanish kroneNorwegian kroneSwedish kronaAustralian dollarNew Zealand dollarThai baht
PassiveCzech korunaMexican nuevo pesoPolish zlotySlovak koruna
6.1.4 Benchmark or actual asset weights to be hedged?This is an interesting and somewhat philosophical question. Let me give an example. Supposethe sample portfolio above is the benchmark weights at a particular period, and that the activeequity manager is overweight euro by 5% of the portfolio (i.e. 40% allocation vs. benchmark35%), and underweight Japan (i.e. 15% vs. benchmark 20%).If the equity manager has an unhedged benchmark (as would be common if the passivehedging is separately executed by an overlay manager), then:(a) If the currency overlay manager hedges the benchmark weights, and the equity manageris not permitted to currency hedge, all equity bets will include a currency bet which willbe the responsibility of the equity manager. This nails responsibility for performance ontothose who will have to account for it, but limits the equity manager’s freedom to bet onthe euro equity market without betting on the euro.
Passive Currency Overlay
Box 6.3
109
Proxy hedge
Proxy hedging is the practice of using one currency to hedge a different currency’s exposure.Let me give an example. Suppose a euro-based fund has an exposure to the Taiwan dollar.The Taiwan dollar is not a hedgeable currency, but the fund may wish to go some waytowards reducing the currency volatility of its exposure to Taiwan. Taiwan has had a seriesof exchange rate arrangements, and for most of the relevant history it has closely trackedthe US dollar. The Taiwanese government exerts strong control over the exchange rate viaa structural surplus and very large foreign currency reserves.The following is a graph of spot exchange rates of the Taiwan dollar (TWD) versus theUSD and the euro (pre-1999, rebased Deutschmark):TWD vs. EUR & USD(1983–2002)
45.00TWD vs. USDTWD vs. EUR
40.00
35.00
30.00
25.00
20.00
83
85
87
89
91
93
95
97
99
01
In the short-term, the TWD is much more volatile against the euro than against the dollar.Its annualised volatility against the euro is 12.3%, versus 5.5% against the dollar. From aeuro perspective, the dollar accounts for some 79% of the variance of the TWD versus theeuro, and using the US dollar as a proxy currency to hedge the Taiwanese dollar will reducethe volatility associated with currency risk to around 5.5%.Proxy hedging was very common for USD and GBP-based investors in Europe preeuro. The Deutschmark and the French franc were commonly used as representatives of‘strong’ and ‘weak’ European currencies, respectively. However, the advent of the euro haseliminated the need for European proxy hedging of this nature. Unhedgeable Paciﬁc Rim,Eastern European and Latin American currencies now constitute the bulk of the currenciessubstituted by proxy currencies for hedging purposes.(b) If the currency overlay manager hedges the benchmark weights, and the equity manager is also allowed to tactically currency hedge back to the benchmark weights (i.e. ifhe wants an equity bet but not a currency bet), then equity bets do not automaticallyinclude a currency bet. This gives the equity manager more freedom, but also allows
110
Currency Overlay
the equity manager to make tactical currency decisions separately from equity decisions.However, the fund client may feel this gives a specialist currency decision to the wrongmanager.(c) If the currency overlay manager hedges the actual weights, and the equity manager istold this, and not permitted to currency hedge, the equity manager needs ideally to havehis performance adjusted for the performance of the tactical hedges (i.e. the differencebetween the benchmark weight hedge and the actual weight hedge), otherwise he will beheld responsible for currency bets (in this case overweight euro/underweight yen) whichare not actually taking place (because the currency overlay manager has neutralised them),and which have been excluded from the responsibility of the equity manager. This isprobably too complicated in practice. If the equity manager does not have his performanceadjusted for the tactical currency hedges, there is a misalignment of responsibilities andpowers.(d) Finally, if the currency overlay manager hedges the actual weights, and the equity manageris also allowed to tactically currency hedge back to the benchmark weights (i.e. if he wantsan equity bet but not a currency bet), then there is a real conﬂict. This could cause doublehedging, creating risk at the fund level. The only redeeming feature of this approach isthat it aligns responsibility for the performance of the equity manager with control of hishedging contracts.Of these alternatives, (b) gives partial control of currency hedging to a non-specialist, (c) isunattractive because of the complexity, (d) is fatally ﬂawed, which leaves (a) as the mostappealing route.6.1.5 Denominator of ‘contribution from hedging’This issue is related to the question of which currencies are included in both the passive hedgeand the benchmark. ‘Returns’, expressed as percentages, are the meat and drink of investmentreporting. But returns have to be expressed as a percentage of something, and this questionasks: ‘a percentage of what?’If the answer is ‘all international equities’, then the ‘contribution from hedging’ will bediluted by the inclusion of assets in currencies which are not being hedged in the denominatorof the calculation. If the answer is ‘hedgeable currencies only’, then the resulting percentagereturns will not be comparable with any published benchmark, nor will the ‘contribution fromhedging’ be able to be added to anything other than the returns of the hedgeable currencyassets.6.1.6 Frequency of asset valuationThis is important only because the rebalancing frequency cannot be higher than the underlyingasset valuation frequency. In most institutional asset management environments, valuationfrequency is monthly. In pooled vehicles, the frequency can be higher, often daily. Assetvaluation is usually provided to overlay managers by the (global) custodian (if there is one)or by the equity manager. The speed of valuation, and its consolidation into the custodian’sdatabase, is important for the mechanics of rebalancing (see below).
Passive Currency Overlay
111
6.2 REBALANCINGRebalancing is the process by which the amount of currency exposure hedged is adjusted totake account of subsequent changes in the value of the underlying