RECan Global, in partnership with 7orca Asset Management AG, is offering investors optional EUR/CAD currency overlay management with respect to its Luxembourg-based RECan real estate funds with targeted investments in Canada. Maximilian Kühl is Senior Investment Advisor at 7orca Asset Management AG in Hamburg. With its experienced team, the company supports institutional clients with customized solutions for hedging foreign currency risks.
Currently, factors such as the Corona pandemic and geopolitical events are influencing the markets, leading to rising inflation and higher interest rates , increased uncertainty and actively regulating central bank decisions, which guides decisions of local investors. How do you view these influences considering current rising currency hedging costs?
Perhaps first of all, fundamentally, currency hedging costs arise from the interest rate differential between two economies. And that varies considerably at times, depending on how long you want to hedge for. This heterogeneity of hedging costs is very much driven by central banks.
And if the Bank of Canada, as we have seen in the past, raises interest rates faster than the European Central Bank, this leads to an increase in hedging costs across the entire maturity structure. This is a fundamental comment on the current monetary situation.
The causes of this development are precisely these factors that are described in the question. We had the Corona pandemic. As a result of that pandemic, global supply chains have been disrupted.
That triggered a massive supply deficit. On the other hand, governments then stepped right into this situation and took demand-stimulating measures, which then significantly created a demand overhang. This overhang ultimately led to the inflation problem that we are currently seeing increasingly and worldwide.
Some central banks, such as the Bank of Canada, reacted to this earlier and raised interest rates. That then led to these hedging costs expanding.
That happened very quickly as the central banks in North America in general, and Canada in particular, reacted much more quickly to this development than the European Central Bank, as we see now, was relatively late in responding to inflation concerns.
This has not only increased the interest rate differential, but also the hedging costs.
From your point of view, what does this mean in terms of Euro into Canadian dollars this year and in the years to come, will hedging costs affect any returns and thus call such investments into question?
You can't say across the board that rising hedging costs will kill returns. The European Central Bank, and this was just a first step, has indeed held out the prospect of raising the interest rate by 25 basis points.
But it has also held out the prospect of more aggressive action in September. Which then means that the hedging costs will only expand as long as the European Central Bank does not act in tandem with the Bank of Canada. That means that if this path is now followed and if interest rate increases take place, then it will of course lead to this interest rate differential remaining constant in terms of time and the hedging costs not widening any further.
That is, of course, an argument for ensuring that investors' returns are not further burdened. That's why I'm quite optimistic here, also because the causes of inflation are global in nature. Ultimately, this means that global action must be taken in unison to combat this inflation. And if this is done in unison, it will also be reflected in a stabilization of hedging costs.
7orca secures tailor-made active and passive currency overlay solutions for investors according to their individual specifications. What is the difference between these two strategies?
Simply put, passive currency hedging means that you specify a fixed foreign exchange hedging ratio, which is then adhered to at all times. Active hedging, on the other hand, means that the hedge ratio is given the leeway to adjust to changing market conditions.
For example, if foreign currency rates rise, then the hedge is reduced to allow the investor to participate in the appreciation movement. In falling markets, a hedge is built up to then create an asymmetric risk profile so that a hedge exists in the falling markets and the highest possible participation can be created in rising markets.
What development regarding the Canadian central bank and consequently what developments with what average currency hedging costs in relation to EUR/CAD does 7orca expect for the coming years?
This essentially depends on the relative developments and the price levels of the two economies. But also, on the will of the central bank, as just described, to act against this increase. The Bank of Canada has made it very clear that it will not compromise on price stability, and the European Central Bank is moving a bit more slowly.
But it should gradually converge through the interest rate steps as time goes on. So, for the time being, we don't expect the hedging costs to come down yet this year, that there will be a sharp decline. But we assume that the peak will be reached at least in the next few months and that in the coming year they will level off again at the usual level of previous years.
Although, of course, it always has to be said that this is always subject to the condition that the central bank takes its mandate seriously in order to ensure price stability. So there is always a conditional constraint behind it.
With the time horizon of an investment period of 10 years in mind, which of your two (currency hedging) strategies do you recommend to institutional investors who are considering investing in RECan funds, for example?
Of course, that always depends on the individual needs of the clients and their investment decisions. For example, if you consider currency risk as a pure risk factor and want it to be eliminated as cost-effectively as possible, or you are committed to a certain hedging ratio, then it is advisable to opt for passive hedging.
I recommend a so-called maturity management to optimize costs, because hedging expenses can sometimes vary considerably over the yield curve. And then it depends very much on where exactly you position yourself now and what maturity you want to hedge. If you look at active hedging, then that comes into question primarily for customers who see currency risk more as an opportunity or as a potential source of return.
Then you can do market-adaptive hedging. 7orca is also able to take into account the risk/return needs of the client by choosing an appropriate benchmark and hedge more offensively or defensively, depending on the client's willingness. If, in addition, there is an individual market assessment that the Canadian dollar is more likely to appreciate against the euro, then such an adaptive hedge can of course be an excellent compromise between a conservative approach and possible participation.
If one is also considering an active hedge, then the shorter the intended hedging term, the more relevant the timing of the entry. If you are aiming for a long-term horizon, as RECan Global does with the two funds in its offering, then this is of course a good starting point for the more active option, because the timing of the entry then becomes less relevant.
Thank you very much for the interview!
The interview with Maximilian Kühl was conducted by Jan Kaulfuhs-Berger in German, and translated into English.
Director of Corporate Communications
RECan Global GmbH
T: +49 89 20 20 55 47