How a custodian can help family offices mitigate currency risk

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It’s known as currency risk, FX risk or exchange rate risk. When the value of international currencies fluctuates, such risk has the potential to devalue international investments, transforming a profitable holding into a money loser. Currency hedging strategies can mitigate the impact of currency risk, but many Canadian family offices overlook the value of putting such strategies into practice.

Sylvia Rizk, senior director at RBC Investor Services (RBCIS), notes that the Canadian family offices with whom she’s recently communicated list their top three concerns as recession, inflation and geopolitics.

“There’s an element of currency risk in all of these concerns,” she says. “No matter what economic situation we face, there’s always going to be a disparity between the value of national currencies. Even those family offices who recognize this risk may not have taken the next step to determine just how currency risk is affecting the performance of their portfolios. If they haven’t established a currency hedging strategy, it’s certainly something they should consider.”

The North America Family Office Report 2023, developed by RBC and Campden Wealth, notes that North American family offices maintain a higher proportion of equities in their portfolios (29 per cent) than global family offices do (27 per cent). Many of those investments are distributed globally. Hedging the currency risk inherent in global investments offers the potential to separate that risk from equity asset allocations. Even family offices invested largely in U.S. equities face currency risk: when the greenback depreciates relative to the Canadian dollar, it can negatively impact the portfolio.

Rizk recounts the experience of one RBCIS client, a Canadian family office with assets of approximately $1.5 billion. RBCIS was custodian of the family assets. The client had expressed concern about the impact of central bank decisions, political conflict and increased volatility in equity and fixed income markets on the overall financial performance of the family office portfolio.

“They felt an increasing pressure to manage that risk, especially as it related to foreign exchange, and to generate a return if possible,” Rizk says. “But they also recognized their lack of specialized expertise to navigate the currency market. Following several discussions, we presented them with the RBCIS currency hedging offerings.”

The family agreed that RBCIS would establish forward contracts, a type of currency fluctuation insurance. These contracts exchange a fixed amount of currency at a future date at a specified rate. The value of such a contract fluctuates and essentially offsets the currency exposure in the underlying assets.

Rizk says the family benefited from this arrangement in three ways. First, it mitigated the impact of major currency fluctuations on the performance of the portfolio. It also allowed the family to benefit from the scale and expertise of RBCIS, whose access to deep market liquidity provided highly competitive forward contracts on the family’s behalf.  And finally, the family office was able to outsource its currency hedging strategy to a trusted agent, instead of hiring additional staff with the required expertise. This enabled the family office to focus on managing the underlying investments of the portfolio, instead of navigating the unpredictable foreign exchange market in-house.

RBCIS offers currency hedging strategies among 70 international currencies, leveraging the strength of RBC’s brand to negotiate optimal terms for currency hedges. Clients can allocate all or part of their portfolio to currency hedging. They can also tailor currency hedging strategies to their particular goals, risk appetite and view on how international currencies might perform.

The strategic options include:

• Active currency hedging, which involves hedges directed by a portfolio manager with varying parameters, instead of employing a rules-based approach.
• Passive currency hedging, which is based on a set of rules designed to mitigate global currency exposure at all times. Clients can define their rules and strategy with RBCIS, who would then manage the FX strategy.
• Hybrid currency hedging, which is a rules-based approach augmented by the insights of a portfolio manager, who can change the hedges based on the exchange insights.

Rizk notes that, executed optimally, currency hedging strategies can go beyond simple insurance and potentially generate alpha.

“Even if a family office has never considered currency hedging strategies, they should at least be looking at the effect of currency fluctuations on the overall performance of their portfolios,” she says. “By being aware of the currency hedging strategies available to them, they can seek that insurance when an opportunity presents itself — and perhaps even generate some additional income.”

This story was created by Canadian Family Offices’ commercial content division on behalf of RBC Investor Services, which is a member and content provider of this publication.