Thought Leadership Series

May 2010

CONTENTS Currency Hedging - Impact of FX risk on the

Executive summary 1
investment process and its effect on performance
Key findings 2

The hedging process is

“business as usual” for now 2

Volatility is seen as the driver Introduction

of volumes 2
The crisis that rocked financial markets in 2008 spurred global investors to examine the
Currency-returns view is strategies they often use to manage, and in some cases, mitigate investment and currency
becoming dominant 2 market fluctuations, as well as the impact such market swings have on investment objectives.

Is behaviour changing? 2
Methodology 2
Research tailored to this
project 2
Contents 2
We at BNY Mellon wondered how efficiently investors were using hedging strategies as part
of their investment approach, and to what end. Were these investors hedging to pursue excess
returns, manage potential return risk to investment performance, or to achieve some other
objective?
To find out, we commissioned ClientKnowledge, an independent research and consultancy
firm based in London, to research investors’ opinions and perceptions regarding the use of
hedging strategies. The results of the ClientKnowledge research are included herein for your
review and comment.

Current behaviour 3
Hedging 3
Assessment of hedging 4
As a thought leader and premier provider of FX products and services, we are always looking
to share information with our clients, including information that stimulates discussion on an
important topic such as managing risk. The opinions and conclusions in the report are that of
ClientKnowledge and its employees and do not necessarily represent the views and opinions of
BNY Mellon.

Volumes 5

The low-yield environment 6

Yields 8

Chasing returns 9

Looking forward 11
Executive Summary
Rather than subject themselves to the random mercy of fluctuating foreign currencies,
institutional investors are taking a more active role in foreign exchange management. Through the
application of hedging strategies in cross-border investments, institutional investors are looking
to the foreign exchange market as a means to reduce risk, take advantage of interest rate spreads
and amplify returns from overseas investments. To find out how effective these strategies are to
what extent they are being utilized, we surveyed a wide range of institutional investors throughout
North America and Europe. This white paper presents their unique perspectives on:
• Applying cost/benefit analysis to hedging strategies
• The critical importance of yield and interest rate spreads
• Implications for the carry trade
• Key differences between European and North American investors
Institutional investors began to take a fresh look at currency hedging in the wake of the 2008
credit crises. Significant market turmoil created widespread reassessment of investment strategies
as investors sought innovative ways to reduce risk and preserve returns in a volatile environment.
By employing currency hedges, many institutional investors were able to minimize losses during
this period and reposition their portfolios for a resumption in global economic growth. Among
our survey’s most significant findings:
• Cost/benefit analysis of FX hedging needs to be valued against the risk it reduces
as well as creates.
• FX hedging should not be viewed as a balancing item since the performance of the hedge
needs to be clear.
• Scenario stress testing needs to be more robust to account for extreme events and how
portfolios with an F/X hedge will perform in those circumstances.
• The fundamental shift in interest rates around the world needs to be looked upon as an
opportunity to enact F/X hedging.

1
 Key Findings
The hedging process is “business as usual” for now

• Hedging is an everyday essential, but its effects are not always fully understood.

• The full costs of hedging are not being recognised by all market participants – a lack of
detailed understanding of FX exposure and MIS reporting systems concerns contribute to this.

• Fewer investors look at interest rate and currency trends when evaluating hedging – hedging
tends to be a policy-driven activity so short-term opportunities have little or no effect.

• Product risk and trading costs are fundamental to assessing the value of hedging strategy.

Volatility is seen as the driver of volumes

• Market volatility is seen as the main driver behind change in market volume in Europe –
North America views interest rates as an equal driver.

• Market trends in interest rates are considered secondary drivers of market volumes.

• The current low yield environment is regarded as short-term, which is of limited relevance to
investors with long-term horizons and strategies where FX is not central.

Currency-returns view is becoming dominant

• FX exposure is most often a result of investment, rather than a direct opportunity to add alpha

• Low yields have allowed the USD and EUR to become funding currencies by default.

Is behaviour changing?

• The dislocation in 2008 has affected performance and AUM, but investors think the change
will be short-lived and adjustments based on it are limited – the risk that our analysis perceives
is that there is a new environment and investors have not reacted to it yet.

• The lessons to be learnt involve a shift in the assessment of hedging, based on risk assessment
and the impact on returns.

• Maintaining current strategies based on a return to normality seems both risky and to miss an
opportunity to differentiate to investors.

Methodology
Research tailored to this project

In the fourth quarter of 2009, ClientKnowledge conducted 53 interviews with individuals from
North America (21) and Europe (32). Follow-up research and analysis was completed in the first
quarter of 2010. Interviewees were real money investors and came from a range of roles across
the industry, including execution desks, fund managers, CIOs and CFOs.

2
Current behaviour
Hedging

Hedging is a key tool in investment strategy, accounting for almost half of all FX trades globally,
but is viewed and undertaken in a variety of ways. The purpose of a ‘translation’ strategy is simply
to reduce risk on transactions by placing simple hedges to translate the currency risk as it occurs.
In this paper, ‘hedging’ refers to a more active treatment of FX risk, one where managers seek
to actively manage risk using hedging. There is more risk in pursuing such a strategy, however if
understood and done well it can attract clients, especially in the new low returns environment.
The majority of hedging is done in the above ways and use simple instruments with the purpose
of managing unexpected losses and gains, a marked difference to those pursuing an aggressive
excess returns strategy, where the pursuit of alpha (excess returns) is the objective.

Figure 1

Systematic approach: Mixed approach: Excess -returns approach:

• Investor-driven • Discretionary •α-driven
• Pension funds • Investment-driven • Hedge funds
• Property funds
12

10
α-chasing, 8
excess returns-based
α-chasing, 6
strategy
excess returns-based
% 4
strategy
Systematic, 2
model-based 0
Systematic,
strategy
model-based -2
strategy -4

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2/1/875/8/88
1/10/82
4/17/83
7/22/84 8/13/89 2/23
10/27/85 11/18/90

3 month US/JP yield gap 3m

Increasing risk of strategy

Source: 2010 ClientKnowledge research.

18
16
14

Those using purely

60%
systematic
52% methods of hedging are at the conservative end of the 12hedging
10
spectrum; however, more often a mixed 47%
approach is taken using a combination of models
% 8
and
40%
% of respondents

manual involvement,
40% and covering 33% a range of instruments,
33% depending on the nature of
6 the
underlying investment. For example, one portfolio manager 22%
described their approach42as follows:
19% 20%
“systematic and methodical, we develop portfolios
20% and manage the models but we are not tied
0 to them.”
Other feedback indicated that, while models are often used for day-to-day transactions -2 (simple
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9/3/89

10/7/90

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products and major
0% currencies), if a transaction is more complex (exotic structures and minor
Type of product Cost of execution Current market Other
currencies) then people will
and trading stylemake the decisions.
and settlement currency and
interest rates 3 month JPY depo rate
3 month EUR depo rate (calculated)
While hedging is considered to be an everyday tool, it is debatable as to whether it is used
Europe NA

efficiently and effectively. The most obvious indication of this occurred in 2008, when unhedged
and poorly hedged funds performed poorly during times of extreme stress. The majority of
funds operate on a long-term basis, and therefore need a long-term hedging strategy – one which
requires risk-assessment and stress-testing in order to more closely align the hedging strategy
with the purpose of the hedge. However, managing the short-term performance of a fund is also
very important, in order to appeal to new and existing clients who often use the NAV of 100%a fund 88%
81%
as a key indicator to differentiate funds’ performance. Naturally there are costs associated 80%
with
% respondents

hedging, just as with any form of insurance, which must be assessed and incorporated into the
60%
understanding of the true risk of the investment. Attaining the right balance between these factors
40%
is key to a fund’s success.
19%
20%
3
0%
Perceived cost Actual cost
 For longer-term equity and fixed income pension funds the cost and effectiveness of hedging needs
to be carefully considered to balance the short-term cashflow hedging requirements against the
longer term nature of the fund.
12
Background note: A recent example of evaluating the cost of hedging is the reluctance to hedge
counterparty risk on super-senior tranches of CDO’s leading up to the credit crisis. The cost of 10

hedging was often calculated to be “too expensive” for α-chasing,

the structures and much debt was left 8
excess
unhedged, resulting in large losses when the credit returns-based
worthiness eroded. Using a hedge effectively
α-chasing, 6
might impair short term performance, but in this case strategy the attractiveness of the
invalidating
excess returns-based
investment through the cost of hedging would have been invaluable. [Another cautionary note % 4
strategy
here is to ensure the
Systematic, creditworthiness of the insurers]. Understanding how the hedge or lack of 2
it willmodel-based
perform under stress is an important lesson
0
Systematic,
strategy
model-based
Assessment of hedging -2
strategy -4
There are differences between European and American attitudes to hedging when it comes to their

1/10/82

4/17/83
view of the impact on hedging of the low-yield environment. Half European investors see a better
1/10/82
4/1
opportunity as a result of low yields, compared to less than a third of North American investors.
3 mo
Approximately a quarter of investors take interest rates and currency moves into account when
formulating hedging strategy; the remainder
Increasing focus more on the type of product and the style of
risk of strategy
trading, particularly in Europe, and on trading fees, particularly in North America.

18
16
Figure 2: Factors taken into account when evaluating cost and value of hedging 14
60% 12
52%
10
47%
40% % 8
% of respondents

40% 6
33% 33%
4
22% 2
19% 20%
20% 0
-2

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2/13/83
0%
Type of product Cost of execution Current market Other
and trading style and settlement currency and
interest rates 3 mo
3 mo
Europe NA

Source: 2010 ClientKnowledge research.

While the market is beginning to adjust to the environment of heightened risk-awareness in terms
of products used, the inclusion of market trends is not a primary assessment tool, with 33% of
North America and only 19% of Europe considering them when evaluating a hedge.

Clearly, the majority of people do not use the whole range of indicators available to them when
100%
assessing the cost and suitability of a hedge, and therefore are not able to assess these factors to the
fullest possible extent. 80%
% respondents

A full view of the costs of FX hedging is incomplete if i-rate and exchange rate effects are not
60%
considered, and thus not fully reflected in investors’ treatment of cost analysis. Cost analysis is
40%

20%
4
0%
Perceived cost Actual cost
 19% 20%
18

%o
20% 0
16
-2
14
60%0% 12
52%
Type of product Cost of execution Current market Other
10
and trading style and settlement
47% currency and
an increasingly important part of hedging strategy,
40% seen from the client side. interest rates
especially when % 8

% of respondents
40% Europe NA 6
Client-side risk awareness has also 33%
developed into a driver 33%
for fund managers as the costs and risk-
reduction of hedging has a relatively bigger impact on performance than before and has become a 4
22% 2
client concern. The differentiation that can be achieved
19% by managers on the20%basis of their hedging
20% 0
strategies may attract clients. Of course, the risk-return requirements vary by client and an
assessment of target client profiles will and already does play a part in any hedging strategy. -2

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0%
Type of product Cost of execution Current market Other
and trading style and settlement currency and
Figure 3: Disparity between perception and reality of cost of hedging
interest rates
Europe NA

% respondents
Perceived cost Actual cost
Execution and settlement costs Interest rate effects

% respondents
Source: 2010 ClientKnowledge research.

Volumes

Trading volumes and risk taking have reduced considerably since the beginning of the crisis, and,
while 60% 56% market
there has been a recovery, the effects have been felt globally. Overall, 56%volatility is
Perceived cost Actual cost
considered to have impacted more on trading volumes than interest rate trends, although there are
Execution
noticeableanddifferences
settlement costs
between Interest
43%
investorsrateon
effects
either side of the Atlantic; Europe considers interest
% of respondents

rates to
40%have had a considerably lesser effect than volatility, whereas in North America the impact

% of respondents
of both factors has been felt equally

20% 17%
Figure 4: Factors impacting on trading volumes
% respondents
60% 56% 56% 8
0%
Europe NA
43%
Interest rate trends Market volatility 6
% of respondents

40%
% of respondents
4

20% 17%

2
% respondents

0%
Europe NA
Interest rate trends Market volatility

Source: 2010 ClientKnowledge research.

% of respondents

NA 51% 33% 16%

5
 Execution 17%
20% and settlement costs Interest rate effects

%o
%
20
% respondents

0%
0
Europe NA
Interest rate trends Market volatility
The difference between Europe and North America is, to some extent, explained by their different
attitudes
60% to hedging; Europeans tend to favour a more conservative 56%approach56%
with more trades 8
used for hedging purposes. Half of all FX trades are carried out in order to hedge exposures
whereas only a third of the trades43%
in North America were for hedging purposes. In addition, more
North Americans take currency and interest rate fluctuations into account when evaluating a 6

% of respondents
40%

% of respondents
hedge, and are therefore more likely to notice their impact.
4
80%
Figure
20%5: Average % of
17%business split between trading models
2
% respondents
60%

% of respondents
0%
NA Europe NA
51% 33% 16% 40%
Interest rate trends Market volatility

20%

Europe 32% 61% 8%

0%

0% 20% 40% 60% 80% 100%

Translation Hedging Excess return 80

Source: 2010 ClientKnowledge research.

60

% of respondents
Our research has shown that in general that the proportion of ‘hedging’ in US FX business is
% respondents who have seen a change

NA
significantly below that of51%
any other region globally. Real money
33% investors in 16%
the US are more 40
in volume of low yield currencies

100%
clearly polarized between a more sophisticated search for alpha and a simple translation strategy
86% 83%
than80%
in Europe. In the chart above, hedging refers to an active approach to managing risk, but not
67% 20
seeking to use the hedge to produce excess returns (or alpha seeking).
60%
Europe 32% 50% 61% 8%
The40%
low-yield environment 0
25%
20%
The 20%
effects of the changes to low-yield currency volumes have been felt by 63% of investors, some
0% 20% 40% 60% 80% 100%
of whom
0%
have adjusted their strategy on high-yield currencies accordingly.
Translation
Changes to high yield strategy Hedging
Changes to high yield strategy Excess return
The changes are considered a
(developed markets AUD, (emerging markets) short-term opportunity
CAD)

Figure 6: Have changes in low-yield

Europe NA currency volumes led to a change in strategy
in high-yield currencies?
% respondents who have seen a change
in volume of low yield currencies

100%
86% 83%
80%
67%
60%
50%
40%
25%
20%
20%

0%
Changes to high yield strategy Changes to high yield strategy The changes are considered a
(developed markets AUD, (emerging markets) short-term opportunity
CAD)

Europe NA

Source: 2010 ClientKnowledge research.

6
 While investors who have seen the impact of volume changes in low-yield currencies have made
some changes to their strategy, more than 80% recognise the opportunity to be short-term.
In particular, two thirds of investors in North America have adjusted their strategy regarding
developed, high-yield currencies, including funding with USD rather than JPY.

On average, investors think the low-yield environment will last for just under a year, both in
North America and Europe; estimates range from 2 months to two years. Although the predicted
recovery times are similar, doubts about the US and UK economies are higher and it is felt that
European economies are recovering faster. As a result of the lack of faith in US and UK markets,
some investors are choosing to focus on the Euro to explore the opportunity and see GDP
recovery as a long process.

“In our hedging policy we account for the current environment and hence we adjust the extent
to which we hedge, for example we feel that the NZD and AUD are overvalued.”

“We are more aggressive than we were, and while we do still focus on the JPY, we are now
more dollar-centric as the USD has become the new Yen.”

“We are increasing our FX exposure and need to review our standard hedging procedures.
Our investors are increasingly demanding to understand our policy”

Figure 7: USD/JPY yield and volatility

12 40

10 35
α-chasing, 8 30
cess returns-based
α-chasing, 6 25
strategy
ess returns-based
% 4 20
strategy
2 15

0 10

-2 5

-4 0
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9/4/94

12/10/95

3/16/97

6/21/98

9/26/99

12/31/00

4/7/02

7/13/03

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1/22/06

4/29/07

8/3/08
2/1/875/8/88 9/4/94 4/7/02 8/3/08
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4/17/83
7/22/84 8/13/89 2/23/92
5/30/93 3/16/97
6/21/98
9/26/99 7/13/03 1/22/06
4/29/07
10/27/85 11/18/90 12/10/95 12/31/00 10/17/04

3 month US/JP yield gap 3 month USD/JPY historical volatility

Source: 2010 BNY Mellon Global Markets.

This
18 short-term view considers the highly cyclical historic nature of yields as demonstrated by the
USD/JPY
16 yield gap data above. The yield gap plunged to even lower levels during the recession
of 14
the early 1990s and has seen two more significant downturns in the last 25 years. While
interest
12 and exchange rates are important influences on hedging strategy, they should not be the
only
10 considerations taken into account. More in-depth investigation into rate cycles, and their
incorporation
% 8 into the risk assessment of hedging, can only benefit the investment, allowing the
33%
timing
6 of the investment to be a factor in the hedge. For example, historically, a forward buyer of
JPY4 would have clearly benefited from the current yield differential.
22% 2
20%
0
-2
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1/22/06

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3/30/08

5/30/09

market Other 7
y and
 strategy 0 10
s returns-based
% 4 -2 20 5
strategy
2 -4 15 0

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0 10
2/1/875/8/88 9/4/94 4/7/02 8/3/08
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7/22/84 8/13/89 2/23/92
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6/21/98
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-2 10/27/85 11/18/90 12/10/95 12/31/00 10/17/04 5
Yields 3 month US/JP yield gap 3 month USD/JPY historical volatility
-4 0

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6/21/98
9/26/99 7/13/03 1/22/06
4/29/07
10/27/85 11/18/90 12/10/95 12/31/00 10/17/04
Figure 8: Yield convergence
3 month US/JP yield gap 3 month USD/JPY historical volatility
18
16
14
12
18
10
16
% 8
14
33% 6
12
4
22% 10
20% 2
% 8 0
% 6
-2
4
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2/13/83

3/18/84

4/21/85

5/25/86

6/28/87

7/31/88

9/3/89

10/7/90

11/10/91

12/13/92

1/16/94

2/19/95

3/24/96

4/27/97

5/31/98

7/4/99

8/6/00

9/9/01

10/13/02

11/16/03

12/19/04

1/22/06

2/25/07

3/30/08

5/30/09
22% 2
20%
market Other 0
y and
rates -2 3 month JPY depo rate 3 month USD depo rate
3 month EUR depo rate (calculated) 3 month GBP depo rate
1/10/82

2/13/83

3/18/84

4/21/85

5/25/86

6/28/87

7/31/88

9/3/89

10/7/90

11/10/91

12/13/92

1/16/94

2/19/95

3/24/96

4/27/97

5/31/98

7/4/99

8/6/00

9/9/01

10/13/02

11/16/03

12/19/04

1/22/06

2/25/07

3/30/08

5/30/09
Source: 2010 ClientKnowledge research.
ket Other
nd
es 3 month JPY depo rate 3 month USD depo rate
3 month EUR depo rate (calculated) 3 month GBP depo rate
Yields from the major currencies have converged and are now at the levels sustained by the JPY
over the last decade. Inevitably this has created a new lower-yield market environment which has
led to temporary adjustments to strategy among some investors.

“We are now very much currency-return-centric as yields are absent.”

100%
88%
81%
80%
Figure 9: Funding currencies
% respondents

60%
100%
88%
81%
40%
80%
% respondents

19% 18% 13% 18%

20%
60%
6% 6%

40% 0%
Actual cost USD EUR GBP Other
19% 18% 13% 18%
20% Europe NA
6% 6%

0%
Actual cost USD EUR GBP Other

Europe NA

Source: 2010 ClientKnowledge research.

56% 56% 80%

67%

60%
54%
% of respondents

56% 56% 80% 46%

40% 67%
33%
60%
54%
pondents

8 20% 46%

40%
 100%
100% 88%
88% 81%
80% 81%
This has led
practical conditions under which it is possible for former high-yield developed
80%

respondents
respondents
currencies
60%
to become funding currencies, with more than 80% of investors from North America
and Europe
60% using USD and EUR respectively due to their low yields.
40%
“W
40%ith low short term rates for USD, GBP, EUR and JPY offering attractive opportunities…

%%
19% 18% 13% 18%
we20%
have decided
19% to trade more in such currencies. We are now using USD as13%
our funding
18%
18%
20%
currency.” 6% 6%
6% 6%
0%
Actual cost 0%returns USD EUR GBP Other
Actual cost Chasing USD EUR GBP Other
Europe NA
Over half of investors
Europe use FX
to generate
NA alpha,
more so in North America than in Europe. This
follows on from the earlier observation regarding the proportion of business North America
allocates to generating excess returns compared to that in Europe.

Figure 10: Use of FX to generate alpha

56% 56% 80%
56% 56% 80%
67%
67%
60%
60% 54%
% of respondents

46% 54%
% of respondents

46%
40%
40% 33%
33%

20%
20%

0%
NA 0%
NA Europe NA
Europe NA
Use FX to Generate alpha Do not use FX to Generate alpha
Use FX to Generate alpha Do not use FX to Generate alpha

Source: 2010 ClientKnowledge research.

Figure 11: How FX is used to generate alpha

80%
80% 71%
71%
60% 60%
60% 60% 60%
60%
% of respondents
% of respondents

43%
3% 16% 40% 43%
% 16% 40%

20%
20%
8%
8% 0%
0% Europe NA
Europe NA
80% 100% Managed hedge/currency overlay program Dedicated FX fund
80% 100% Managed hedge/currency overlay program Dedicated FX fund
Excess return Source: 2010 ClientKnowledge research.
Excess return

9
86% 83%
 In Europe, however, more investors run a dedicated FX fund than in North America, the same
number as run currency overlay programs, indicating a more sophisticated, cautious approach.

Of those investors who use FX to generate alpha returns, 54% undertake carry trades and look at
interest rates and currency fluctuations in tandem, the remainder only taking a view on individual
currencies rather than interest rates. There is a view to extend such trades into USD, EUR and
GBP, with all North American and half European investors who use carry trades entertaining the
idea.

The North American investors are less risk-averse than Europeans: of the 26% of investors using
carry trades to generate excess returns, more do so in North America, 43%, than in Europe, only
15%. In addition, North Americans are willing to use emerging markets currencies as the high-
yield currency of a carry trade.

The two central methods of generating alpha have major barriers to their becoming mainstream,
and hence for forex to become a contender as an asset class. Firstly, a strategy of latency
arbitrage requires continual and substantial investment in advanced, ever-changing technology.
This requires fast decision-making and implementation and leaves the majority of investors
in a position where by the time the technology has been approved and installed it has already
been superseded by a new innovation. Hedge funds, with their ability to turn a decision into
implementation overnight, are therefore always one step ahead and thus able to monopolise this
strategy.

Secondly, the pursuit of a carry trade strategy in the perceived uncertainty of the current market
offers an unattractive risk-return ratio. Whilst returns can be smooth, the currency move when
the market breaks out can be so fast a reversal the question has to be asked whether the strategy
should be a carry trade or trying to position for the break of the carry trade. The speculative
bubble created and destroyed by such investments adds to the uncertainty in an already volatile
market. The carry trade is also often misleading and a consequence of investment strategy rather
than the strategy itself. However, there is increasing emphasis on emerging markets and this has
the consequence of affecting a carry trade if you are a USD-based investor.

10
Looking forward
Is there a new investment strategy developing as a result of the credit crisis and
consequent low-yield environment?
At the moment, investors are optimistic about economic recovery and, while acknowledging
this may take time, are not taking a long term view on the current conditions, merely using
it opportunistically. If, on the other hand, this is not borne out by events and the assumption
that things will return to “normal” is short-sighted, we may experience a paradigm shift in the
forex market. To follow this to the logical extreme would mean the development of forex into
an asset class in its own right. Although this is fraught with issues and more likely is the more
nuanced use of FX as a hedge or addition to performance. Hence, foreign exchange products
will continue to be used as a consequence of investment in other assets and hence hedging will
increase in importance.

So far low yields, and the resultant low returns on cash, have intensified focus on currencies as
the need to hedge has become more pressing (the currency effect has a proportionally greater
impact in a low return environment as currency volatility is not necessarily lower). People have
become more pro-active in their pursuit of currency returns, which is allowing them to reap
the benefits of placing an effective hedge against their view at the beginning of an investment.
In addition, the pursuit of alpha, both as a result of investment in underlying assets and
proprietary trading, has increased this year, although currency returns as a result of investment,
rather than as a strategy, are still dominant.

“As a result of the new market environment, we have expanded our portfolios exposure to
more currencies. Our hedging program is still the same and needs reviewing.”

One possible outcome of the credit crisis is tighter alignment and greater clarity of the risk of
currency and asset. There would be a need to show the link between the forex exposure and
the underlying asset which would lead to more thorough reporting on FX. For this to come
about, a more detailed system of liquidity management needs to be in place, including an
aggregated view of the market; data mining and analytical tools; efficient back office processes
and transaction cost analysis. The crisis has already focussed attention onto this, particularly
regarding risk.

These measures would allow investors to examine the efficiency of their hedging, taking into
account when an asset was bought, when the hedge was placed and therefore whether the
hedge is as efficient as possible in the scenario. This leads to the possibility of closer scrutiny of
investors’ FX strategy by customers, and consequently differentiation between players based on
hedging strategies. The demand from investors who outsource their FX risk will be for greater
competition and transparency from FX overlay providers.

The new era of risk-awareness will provide both challenges and opportunities for managers. It
may no longer be enough for and investment to ‘be hedged’, rather that hedging becomes an
integral part of investment strategy, whether that means a conscious decision not to hedge or an
effort to bring in excess returns. The opportunity lies in having the appropriate, and attractive,
balance between risk and reward in order to gain and to keep clients, and the challenge is to
determine the thresholds of when and what to hedge. These will ensure that hedging strategies
are relevant, necessary insurance measures, and not just a somewhat random balancing feature
on performance.

“More hedging and less risk is the new order for us.”
 The key balance to be struck is to introduce more nuanced and yet simple, understandable FX
hedging that is aligned to asset managers’ mandate and recognises both the risks being hedged
and the limitations to the model they are employing. Markets cannot function if they constantly
expect the worst scenario, but a significant gain can be realised by better understanding the risks
that are currently being managed, the alternatives to hedging and the risk profile that the hedge
creates on the underlying investment.

All market participants need to take responsibility to incorporate more predictable and effective
FX hedging into the system.

12
About BNY Mellon
BNY Mellon is the corporate brand of The Bank of New York Mellon
Corporation. BNY Mellon is a global financial services company
focused on helping clients manage and service their financial assets,
operating in 34 countries and serving more than 100 markets. BNY
Mellon is a leading provider of financial services for institutions,
corporations and high-net-worth individuals, providing superior
asset management and wealth management, asset servicing, issuer
services, clearing services and treasury services through a worldwide
client-focused team. It has $22.4 trillion in assets under custody and
administration, $1.1 trillion in assets under management, services
$11.8 trillion in outstanding debt and processes global payments
averaging $1.5 trillion per day. Additional information is available at
www.bnymellon.com
This document has been prepared solely for informational
and discussion purposes, for private circulation, and is not an
offer or solicitation to buy or sell any financial product or to
participate in any particular strategy. The Bank of New York
Mellon, and its broker dealer affiliates, may have long or short
positions in any currency, derivative or instrument discussed
herein. The Bank of New York Mellon has included data in this
document from information generally available to the public from
sources believed to be reliable. Any price or other data used for
illustrative purposes may not reflect actual current conditions.
No representations or warranties are made, and The Bank of
New York Mellon assumes no liability, as to the accuracy or
completeness of any data. Price and other data are subject to
change at any time without notice.

Edward McGann +1 212 804 2248 John E. Murray +44 207 964 6268
Managing Director Managing Director
BNY Mellon Global Markets BNY Mellon Global Markets
edward.mcgann@bnymellon.com john.e.murray@bnymellon.com

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