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Winning more investment through cross currency share classes

Cross currency share classes | HCFX

Scenario

The funds and institutional investment space is a broad church. We work in all corners of it and bring value to our clients in a multitude of ways.

In this case study we’ll look at how we helped a fund broaden its investor base without incurring undue risks.

Our client is a private equity firm, with offices in Paris, Stockholm and Madrid. They invest into small-medium sized companies across Europe, with deals sizes in the £10-50m range, where they take a sole majority stake.

They are interested in expanding their investment portfolio to new markets, including Middle East and Latin America, but don’t have much experience of working in these territories.

They’re clear that not only do they want to do deals in these regions but want to raise money for their new funds from there too.

Solution

It’s clear that our client has strong growth ambitions, and the experience in their core market to create significant value in new markets.

Given their plan encompasses so many parts of the world, with so many variables, we decided we would ask where the top two markets were and prioritise those. The markets were Mexico and the UAE.
We started with the fund-raising aspect of their expansion plans and identified that having a local currency share class would make a lot of sense – allowing Mexican investors to invest in Mexican Peso and Emirati investors to invest in Dirhams.

Money invested into the fund in Pesos or Dirhams would be converted into the fund’s primary currency, Euros, before being invested into various target companies.

As such we needed to implement some hedging of the Mexican and Emirati share classes, to ensure that the FX market didn’t reduce the value of their initial investment over time.

So we knew what we were hedging, but the next question was around duration or the hedges.

The fund has a five year lock up period, so it made sense that we were hedging the repayment back into local currency for at least five years. If the fund isn’t divested by then, we can roll the hedge further to a later date.

We debated with the client whether they would be more comfortable using a shorter hedge duration and consistently rolling the position. But with the lock up of five years, it was more cost effective (with less administration) to have a single long dated hedge in place.

Implementation

FX swaps and forward contracts were not new concepts to our client, so getting going was easy.

We wanted to ensure that the fund had the necessary collateral available to post against the trades and though they did, we eventually agreed on a credit line to facilitate the trades without the need to lodge cash with us.

This was better for them because it gave them more money to invest with. It worked for us because we charge a small cost of credit, which covers the cost of us allocating our own cash against a credit line.

We’ve got the solution and process in place, but what about the reporting?

With swaps and forwards, reporting and valuations are key. Hamilton Court’s reporting is fully IFRS9 compliant, and we give the fund a daily position report with valuations in both local currency and the fund’s functional currency, euro. This allows the client to have complete and regular visibility of their currency positions against the daily movement in the spot market.

Outcome

Our client now has a fund structure that is more appealing, to more investors, across more geographies. What’s not to like?!

Their FX risks have been identified and fully mitigated, and we’re happy that we’ve been able to help solve a challenge with a solution that can now be scaled to their lower priority geographies simply and with the same efficacy.

By building a simple, yet robust solution the general partner can focus their energy on their core business rather than worrying about the FX market – which is, quite frankly, out of anyone’s control.

As part of our continuing work with this fund, we now work within their acquired companies to ensure best practice in their own FX and treasury management challenges.

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