This short whitepaper, originally published in Private Equity International's 'Private Debt Investor - The Global Guide to Private Debt', discusses the source of FX exposure for debt funds, the methods of mitigating such exposure, and some of the challenges with the process.
Many debt funds make loans in currencies other than the one in which they report. As a result, they encounter FX risk, in that a depreciation of the currency in which the asset is held versus the reporting currency will lead to a diminution in the asset’s value (and related coupons) as measured in the reporting currency.
Most debt funds seek to mitigate this risk through FX hedging. Unfortunately, there is always a cost to hedging either in terms of credit consumption or cash. Given debt funds’ lower IRR than equity funds, the relative cost of hedging tends to be higher for a debt fund. Nonetheless, in the vast majority of cases, the desire to ‘lock down’ as much risk as possible means debt funds are more likely to hedge than equity funds.
Download this whitepaper to find out how to mitigate risk and the strategies you can implement to avoid negative cash events.