Foreign currency risk management strategies for investment vehicles
In this final post from our three-part research series on design considerations for investment vehicles, we are pleased to share our findings from an ISF Advisors study on foreign currency risk management strategies.
Rural-impacting micro, small and medium-sized enterprises (MSMEs) in Africa require local currency financing to grow and scale. However, the volatility of local currency markets can create high risks for investment vehicles that must be considered and managed if these vehicles are to be sustainable and scalable. In Africa, typical hedging strategies employed to manage currency risks can be costly and often outweigh the potential return for investments in MSMEs, particularly in the agriculture sector.
Small Foundation commissioned ISF Advisors to analyse available strategies for hard-currency funds in frontier and emerging markets to manage local currency risks. Based on this report, we are pleased to present an overview of common strategies and tools for local currency investing with options at both fund and investment level. Understanding each country’s monetary, economic and currency market dynamics is critical to making appropriate risk / return assessments for a balanced and well-managed portfolio. In addition, balancing types of instruments alongside individual investment risk factors can be important in determining the best strategy for portfolio construction.
Of most interest to Small Foundation are mechanisms that are not subsidy-dependent, as the sustainability and scalability of the solution must be considered to maximise impact. Small Foundation does not support any subsidy for currency management at the individual investment level, preferring that investors bear the currency risk. The risk of local market distortions also need to be taken into account.
We are pleased to share this summary report, and recommend readers consider this in conjunction with our first post on liquidity mechanisms and second post on design considerations for technical assistance delivery. It is our view that investment has a critical role to play in eliminating poverty, and we welcome further discussion on these issues.