EMPEA Currency risk management survey
"Invest to the Best of Your Ability and Create the Most Alpha that You Can"
A Conversation with Mounir Guen, CEO of MVision Private Equity Advisers
How are LPs approaching the issue of currency risk in light of the volatility we’ve seen over the last 18 months?
There are different philosophies toward the question of FX risk. In some cases, investors believe that they are in it for the long term, and that over the long term currency risk washes out. But they are actually being reviewed over the short term. So while the planning itself might have a long-term structure, the individuals who are working with the exposure are assessed on their performance on a quarterly basis, which then leads to discussions of comfort with economic dynamics and potential risks.
From the GP perspective, have you seen any best practices with respect to currency risk management?
It’s extremely difficult to protect yourself because you can’t really use structured instruments to manage your portfolio. If you look at general partners that are active in reserve currency markets, you will see that they have quite dynamic policies at the portfolio company level, but not at the fund level. In my experience, when I have seen GPs employ hedges at the fund level, in most cases those hedges have actually taken out a large chunk of the performance, because the instruments are extremely expensive. That’s not to say that there’s nothing to be done—you can work at the company level to mitigate the impact of FX movements, for example by matching revenues to costs and liabilities.
In addition to family groups, we also see firms embracing platform and investment holding companies, which operate like Business Development Companies to a certain degree. Is the traditional LP-GP structure the right model for the region?
This is an interesting question, because a lot of emerging market and new economy funds are in U.S. dollars; and that creates a potential risk at the waterfall level for the general partners. What you will find is that most GPs are open to living with that risk.
Part of the nuance with countries like Japan and Australia is that local investors can invest with local general partners that perform well without having to worry about the fluctuation of the currency. They can truly just focus on the alpha—they don’t have exogenous factors that can impact their final return profile. The reason that these funds earn carry in local currency is because almost all of their capital comes from local investors.
What advice would you give to industry participants who are currently battling FX volatility in their unrealized portfolios?
The best practice is to have a consistent, regular return and have repeat investors who, over the long term, can wash through this. Unfortunately, that’s not always the case. I think the only policy you can follow is: invest to the best of your ability and create the most alpha that you can. If you start becoming too financially focused, you could impact the portfolio by creating a drag during good years and maybe get the hedge wrong. Then it’s unexplainable. The investors won’t tolerate it. They won’t tolerate you making money off the hedge, and they will never tolerate you losing money on the hedge.