Just because something’s running smoothly, doesn’t mean it doesn’t need to be checked now and again. So it is with a well‐functioning hedge program. It needs a review every so often. And the triggers to start a review may come from different sources: a merger, a new leadership team, a bank recommendation, or even a look at how other companies approach similar issues.
At a recent NeuGroup FX Managers’ Peer Group meeting, members of the group gave their perspective in looking at revisiting a hedge program.
What’s reviewed? There was some consistency among members on what hedge program components are reviewed as part of an overall revision of a hedge program. Although reviews of hedging strategies occur at varying times across the board, what is reviewed is more consistent for members. Pre-meeting survey results showed that strategy reviews most commonly focus on the underlying exposures being hedged (83%), hedge tenor (83%), hedge instruments (83%), and hedge ratios (78%). As of the time of the meeting, 37% of members were reviewing all or a part of their program strategy or execution.
As discussed during the meeting, understanding the objectives of your program — as well as the company’s risk tolerance — is critical to designing a new or optimizing an existing hedge program. The pre-meeting survey suggested that most members seek to reduce earnings volatility through their hedge programs, while others seek to minimize deviations from annual budgets/forecasts or reduce volatility in cash positions. Some of these objectives are mutually exclusive and it is treasury’s responsibility to educate management on the trade-offs as well as quantifying the possible effects.
The difference is in the details. Different strategies might perform very similarly over longer periods of time, but there might be differences in how they performed under specific market conditions in the short term.
Some members have introduced flexibility into how they execute their hedging strategy as a way to add value. In some cases, treasury managers can decide between instruments, tenors or hedge percentages depending on their view, as long as they remain inside certain parameters. Regardless of what resources are available in your toolbox, it is important to track the performance of any decision taken against a baseline or benchmark to understand the value being added by this flexibility.
Market conditions, as well as internal factors such as M&A activity and changes in management, triggered a wave of reviews of FX programs’ performance in late 2015. This trend continued throughout 2016, as volatility is the main concern.