Similar views have been put to Bryan Gray, head of JP Morgan Worldwide Securities Services ( JP Morgan WSS) in Australia. He says clients believe transaction and brokerage are best left to investment managers. “Clients evaluated what the benefits would be of a master manager program and haven’t seen value in taking execution away from managers and executing themselves,” he says. “They don’t want to interfere with managers’ trading. That’s the managers’ job. They don’t want a manager to say: ‘I couldn’t get outperformance because execution was taken away from me and given to the custodian’.” But the clients like tax parcelling, and also passive currency overlay services – particularly if custodians are part of financial institutions with forex execution capabilities.

Gray says asset consultants approached the custodian to run a passive overlay because they already knew funds’ currency positions. The overlay is a basic, rules-driven product, Gray says, in which hedging ratios and rebalancing disciplines are set by clients. It doesn’t rely on the custodian’s judgment. While Mercer Sentinel gives the product its overall approval, David says clients should be fully aware of the differences in the types of service run by overlay managers and custodians. “If you think about what fund managers do, they apply a judgment as to what the market conditions are. It’s an enhanced FX service based on a clear framework from the client,” she says. “The approach of the people doing the decision making is different and their background is different. Custodians are acting as a facilitator in relation to the strategic asset allocation or a 50 per cent hedging ratio. In that sense, there’s no investment approach applied at all.”

Because they are following rules, custodians will bear responsibility for keeping the hedge in place, but not for the investment performance of the overlay. “Custodians will act on instructions, but they don’t want to be responsible for whether that hedge was the right decision. “But what if the action resulted in an error that had costs associated with it? How far would custodians go to make amends?” In contrast, investment managers running overlays are under much greater liability and are rated on their performance. “They are constantly under the microscope.” David says the currency overlays are “absolutely” a good service. But they best suit funds with basic offshore exposures consisting primarily of equities, bonds and few alternatives. However, since the execution of the overlay is done by the parent institutions’ trading desk, it’s important that this trust is not exploited, she adds.

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