The strengthening U.S. dollar has posed significant challenges for fund managers, impacting returns and driving up operational costs for 83% of them, according to a new report. The MillTechFX North American Fund Manager CFO FX Report 2024 highlights how fund managers are adapting to these challenges by extending hedge tenors and increasing automation in response to ongoing foreign exchange (FX) market volatility and upcoming U.S. elections.
Expansion of Hedging Practices
The report, which surveyed 250 senior finance executives, reveals that 65% of fund managers are planning to extend the duration of their hedging strategies, providing longer-term protection against FX market fluctuations. Additionally, 34% of respondents indicated they intend to increase their hedge ratio, aiming to shield a larger portion of their portfolio from currency risks.
A significant 83% of the fund managers surveyed reported that the stronger dollar has negatively affected their returns, while 81% noted an increase in operational costs, with 34% experiencing substantial rises. Nearly all respondents (93%) expressed concern over the impact of the stronger dollar on their foreign market exposure, with 46% indicating significant concern.
Election-Driven FX Market Concerns
The report underscores the growing concern among North American fund managers regarding the potential effects of the upcoming U.S. elections on the FX market. The key worries include increased volatility (40%), policy shifts impacting currency values (37%), and unpredictable market movements (37%).
Fund managers are particularly focused on the potential risks associated with policy changes and counterparty exposure in hedging transactions. As a result, many are adjusting their strategies, with 65% planning to extend their hedge tenors to better protect against market instability.
Eric Huttman, CEO of MillTechFX, commented on the situation: “It’s an intriguing time for the FX market in North America, with the dollar strengthening against expectations and the U.S. presidential election looming, which is likely to influence market dynamics. Fund managers are understandably concerned about these FX implications and are increasingly adopting proactive measures to secure their currency exposures for longer periods in this uncertain environment.”
Rising Hedge Ratios and Costs
To tackle these challenges, 79% of fund managers are now hedging their forecastable currency risk, an increase from 72% in 2023. The average hedge ratio has risen to 55%, up from 50% last year, while the average hedge tenor has extended to 5.41 months from 4.96 months. Despite these adjustments, 80% of fund managers have observed a rise in the cost of hedging over the past year.
Automation and Operational Adjustments
The report also highlights a trend towards increased automation among fund managers, with nearly all (99%) exploring new technologies. A significant focus has been placed on process automation (41%), while 31% are considering the full automation of their FX workflows. Nevertheless, many fund managers continue to rely on manual methods for FX operations, with 26% managing transactions via email and 24% over the phone.
T+1 Settlement and Rising Costs
As fund managers prepare for the transition to T+1 settlement, many have made operational adjustments, including increasing staff (45%), improving counterparty communication (43%), and upgrading IT systems (42%). Despite these efforts, 78% reported that the shift to T+1 has led to higher operational costs.
Eric Huttman further noted, “The significant operational changes in preparation for T+1 settlement have resulted in increased costs, but this investment has ensured a smooth transition, with no decline in processed volumes, according to CLS.”
Key Challenges in FX Markets
The report identifies the primary challenges fund managers face in the FX market. The top operational concern is cost calculation (30%), followed by onboarding liquidity providers (28%) and securing credit lines (26%). The top priority remains managing FX counterparty credit (36%), with uncollateralized hedging following closely behind (29%).
These findings highlight the volatility currently present in FX markets and the strategic adjustments North American fund managers are making to mitigate risks and manage costs effectively.
