There’s growing demand from private wealth investors to gain greater access to private markets through evergreen or semi-liquid funds that offer liquidity along with higher returns. Managers are vying to attract these investors across Europe and APAC by offering multi-currency share classes in these products, which help insulate investors from FX volatility and performance erosion.

Lata Vyas and Mike Carney, Managing Directors with BBH, discuss the demand these hybrid structures are creating for FX hedging solutions among global asset managers.

What is driving the activity in semi-liquid funds?

Vyas:  Globally, more traditional and alternative asset managers are developing evergreen fund structures, also known as semi-liquid funds. Unlike traditional closed-end private market funds that rely on big institutions for capital, semi-liquid private asset funds are targeted at a broader set of private wealth channels, including ultra-high-net-worth/high-net-worth investors.

Evergreen funds in the US, such as Business Development Companies (BDCs) or interval funds, have been attractive investment strategies for nearly two decades. In the EU and UK, recent regulatory changes have been positive for retail investors looking to invest in private asset semi-liquid funds, such as the UK’s Long Term Asset Fund (LTAF), Luxembourg’s UCI Part II Fund, and the EU’s European Long-Term Investment Fund (ELTIF). ELTIFs, in particular, are currently at a modest AUM of EUR 13.6 billion, but are estimated to grow to EUR 30 – 35 billion by 2026¹.

For managers, at a time when fundraising is proving more challenging through traditional institutional channels, semi-liquid private asset funds can open up a new investor base. For a traditional asset manager, leveraging well-established distribution channels can create an opportunity to tap into the higher fee margins typically associated with private assets.

For investors, semi-liquid funds can provide better returns and risk diversification, at least when benchmarked against existing – perhaps more liquid – asset classes. When compared to more conventional closed-end private market products, semi-liquid funds also offer liquidity, albeit with limited redemption terms and potential lock-up periods.  

Why is this leading to a greater focus on FX hedging?

Carney: The semi-liquid fund market is increasingly competitive. To make products more attractive, managers are structuring products to appeal to a global investment base. Establishing foreign currency feeder funds or offering multi-currency share classes increases asset managers’ access to a broader distribution network. To optimize investor demand, asset managers are incorporating currency hedged investment options to mitigate FX volatility risk for underlying investors. Due to the simplicity of the FX spot and forward markets, managers gravitate toward these instruments to hedge their underlying currency risk.

What are the key considerations for managers?

Carney: New semi-liquid funds in Europe must retain a degree of liquidity in their portfolios to meet possible redemption terms. In fact, some managers will have 10 - 30% of their holdings in liquid assets. However, there are a few areas specific to semi-liquid funds and their respective FX hedging strategies that managers should consider:

1.     Align process design

• The context: Semi-liquid fund events, including NAV publication, subscription and redemptions, and distribution activity, are often based on extended settlement timelines and valuations that can be delayed because of the underlying asset strategies. Even with less liquid assets, many managers do not want to immediately divest their positions to fund their hedge P&L or meet redemption or subscription cycles.
• What to consider: Managers are showing interest in hedging programs that align all possible cashflows within the product. An embedded FX hedging process aligned with the fund event cycle can give managers the ability to assess capital and asset level cash flows collectively to determine their hedging requirements and subsequent cash liquidity needs.

2.    Collateral and credit

• The context: Historically, the illiquid nature of alternative structures has made FX counterparties reluctant to support uncollateralized trading relationships. However, by mitigating these liquidity constraints through effective hedging programs, managers now can reduce performance drag associated with fully collateralized FX hedging programs. One implicit cost of uncollateralized trading may be captive execution, where credit fees are embedded within spreads.
• What to consider: Maintaining a sufficient level of liquid assets combined with a hedging program aligned with fund liquidity events, can enhance managers’ flexibility in obtaining unsecured FX trading lines. Managers are aiming for the best of both worlds by pursuing uncollateralized trading through multi-bank liquidity arrangements to secure competitive executions.

3.     Investor transparency

• The context: Newly launched semi-liquid funds often require FX hedging at portfolio and investor levels. While this is not particularly common in the pure alternatives space, it’s business-as-usual for many cross-border distribution strategies. 
• What to consider: There are two features critical to demonstrating the effectiveness of the hedge for managers’ underlying investor base:    
  • A performance attribution model that explains the various factors creating hedged versus unhedged performance deviation.
  • A highly efficient multi-bank agency execution model where liquidity is sourced competitively from a range of FX counterparties, with the goal of compressing market spreads. This added transparency has become an essential component of FX hedging programs.

The big takeaway: As more managers explore semi-liquid structures and competition increases in this space, we expect an uptake in fully embedded FX hedging programs. This approach creates an automated, scalable solution for cross-border distribution that can amplify the potential of semi-liquid funds and make it easier to reach a global investor base.