What is hedging and what are currency hedged classes?

‘Hedging’ is a way for people to make things less risky and uncertain, as in ‘hedging your bets’. When you invest in something, like a fund, there are two parts to how much money you make:

• How well the fund itself performs (in what is termed the base currency of the fund)
• How the currency of your chosen unit or share class performs compared to the base currency of the fund

Currency-hedged classes attempt to reduce, but cannot eliminate, the effect of the currency performance component.

Hedging strategies use a range of legal agreements known as derivative contracts, like currency forwards, futures, options, or swaps. Derivatives are investments whose value is derived from another underlying asset.

An example

If a fund’s base currency is US dollars (USD) and someone wants to invest in a euros (EUR) class, they have two options.

• They could choose an unhedged EUR class. This means they'll be affected by how the value of USD and EUR change relative to each other. This may have a positive or negative effect on the overall return received by the investor because it’s unknown how the currencies will behave.
• Alternatively, they could choose a EUR hedged class (if it's available for that fund). This kind of class tries to make the changes in currency values less important. It aims to make the return you get closer to the return you would get if you invested in the fund’s base currency, USD. By doing this, the investor tries to reduce the risk of currency changes and at the same time, have a class that publishes prices in euros.

Important things to know

• Currency hedged classes only try to manage the risk related to currency changes. Other risks are still the same as in classes that are not hedged.
• Hedging is never a perfect strategy. There are some limitations to the hedging process.
• Any money gained or lost from the hedging transactions is borne separately by the investors in the currency hedged class.
• The goal is not to make extra money for the currency hedged class. It's just meant to manage the risk related to currency changes.

How does the hedging process work?

Artemis offers currency-hedged classes on certain funds. They take two different approaches to hedging: 'Net Asset Value (NAV) hedging' and 'Portfolio hedging.'

• NAV-hedged classes is the more commonly used approach and uses transactions to reduce the risk of the currency changing between the class currency and the NAV, expressed in the base currency of the fund. They usually try to hedge 100% of the value of the class.
  (The NAV is the total value of a fund, measured by taking the total value of its assets, less its liabilities. The NAV per unit or share is calculated by dividing the resulting number by the number of units or shares in issue. This term is used to describe the underlying value of a fund's units or shares.)

• Portfolio-hedged classes use transactions to reduce the currency risk between the currencies of the different things the fund invests in and the class currency. For example, if the fund has half of its investments in US dollars and half in euros, portfolio hedged classes would be separately hedged for those two currencies into the class currency.

When you look at the fund's prospectus, it will tell you if the hedged classes offered use NAV hedging or portfolio hedging.

The hedged classes aim for a target hedge ratio of 100%, which means the class aims to be fully hedged. There's usually a small allowance for a little bit more or less hedging. This helps to minimise the number of transactions needed to keep things balanced.

An important point

Some funds automatically hedge the currency risk for all the different assets the fund invests in. It's like a special rule they have for their investments. This is different from currency hedged classes because in this case, all the people who invest in the fund get the protection from currency changes, not just those in specific hedged classes.

Artemis offers some funds that hedge the currency risk of all of the different assets in the portfolio automatically, as well as offering currency hedged classes. If you look at a fund's prospectus, you can find specific details on what is offered.

What are the potential benefits of currency-hedged classes?

• They help reduce the risk of changes in value due to changes in currency exchange rates. This means you are able to worry less about how currencies perform.
• They try to make the returns you make more like the returns you would make in the base currency classes.
• It's simpler for investors. Hedging currency risk can be complicated and confusing. But when you invest in a hedged class, you don't have to do anything extra. The hedged class automatically takes care of reducing the risk of currency changes.

What are the potential drawbacks of currency hedged classes?

• Missing out on positive currency changes: When you invest in a hedged class, it can protect you from losing money if the currency changes in a negative way. But it can also limit how much you gain if the currency changes in a good way. So you might not make as much money as you could have.
• Hedging might not always work: Sometimes, even with hedged classes, the protection against currency changes might not be perfect. The intention is to be fully hedged but it's not always exact.
• There are extra costs: The hedging process costs some money. These costs can affect the returns you make in the hedged class. Only the people who invest in the hedged class have to pay these costs, and benefit or suffer from any gains or losses from the hedging transactions.
• There are some limits: Hedging isn't a magic solution. There are some things that make it not perfect. For example, there can be delays between calculating the value of the investments each day and placing the hedging transactions, leading to imperfections. Also, changes in short-term interest rates can make the hedging less effective.

Do currency hedged classes affect other investors in a fund?

In a fund, the different classes are not kept separate. This means that if something happens with the hedging of one class, it could also affect the other classes in the fund.

So, there is a chance that the hedging transactions in a hedged class could create problems that could affect the other classes in the same fund. It's important to know that there can be a connection between them.