Investment Funds Offering Currency Hedged Class or Series
This article was originally published in the Investment Funds Practitioner in September 2016.
Staff have observed recent developments in how a class or series of an investment fund is established for the purpose of employing currency hedging strategies (the Hedged Series).
Under subsection 1.3(1) of National Instrument 81-102 Investment Funds (NI 81-102), each class or series of an investment fund that is referable to a separate portfolio of assets is considered to be a separate fund. As gains and losses associated with Hedged Series derivatives used to deliver currency hedging are referable only to the Hedged Series and not to all classes or series of the fund, the Hedged Series portfolio may differ from that of other series offered by the fund. Historically, fund managers have offered Hedged Series to provide this attribute to investors in the fund in order to allow for greater operational efficiency. This practice has been based on expectations that fund managers:
- have systems in place to accurately track the currency hedging instruments used in a Hedged Series, separate from the other class or series of the fund,
- properly apportion currency hedging costs to a Hedged Series, and
- have structured a Hedged Series such that investors understand the features and performance of the Hedged Series versus the other classes or series of the fund.
While staff's acceptance of the Hedged Series was historically based on the expectation that the Hedged Series would hedge all or substantially all of the foreign currency exposure associated with the investment fund's portfolio, recently we have seen some variations on this concept. For example, we have seen a Hedged Series employing discretionary currency hedging where a portfolio manager hedges anywhere from 0% to 100% of the Hedged Series' foreign currency exposure. In such circumstances, staff question whether it continues to be appropriate to consider the Hedged Series to not be a separate investment fund. Other variations that could result in different series having differing levels of discretionary currency hedging also cause us to question the appropriateness of this structure. Accordingly, we may raise comments during our prospectus reviews with a view to better understanding how these concerns are addressed.
Also, in giving further consideration to this type of structure, staff are concerned that, as currency hedging is typically not disclosed as part of the investment objectives of an investment fund that offers a Hedged Series, the manager may take the view that it can change or eliminate the currency hedging employed by the Hedged Series without securityholder approval. Staff, however, take the view that currency hedging is an essential aspect of a Hedged Series, which may be further bolstered by the name of the Hedged Series, or the manner in which the Hedged Series is marketed.
Accordingly, staff will request, as part of our prospectus reviews, that a fund that has a Hedged Series include in its prospectus disclosure that prior approval of securityholders of the Hedged Series will be obtained before the currency hedging strategy of the Hedged Series is changed. This will ensure that securityholders who purchased the Hedged Series for the purpose of obtaining currency hedging are given an opportunity to vote on any changes to this fundamental aspect of their securities.
Staff will continue to review and monitor developments with respect to currency hedging strategies employed by investment funds and will consider whether additional guidance or rule-making is needed in this area. Filers are encouraged to consult with staff in structuring classes or series of securities that may give rise to these issues.