UK fund managers plan to raise FX hedges on volatile pound, report says

A MillTech survey of over 250 UK fund managers shows 48% plan to increase hedge ratios and 46% plan to lengthen FX hedges in the next year as sterling volatility rises around the UK budget and global policy uncertainty. Mean hedging ratios have fallen to 46% (the lowest since before 2023) while average hedge length nudged up to 5.5 months; the cost of hedging has surged 69% year-on-year and almost one-fifth of respondents said costs had more than doubled. Managers report widespread losses from unhedged FX exposure, more than half of current non-hedgers are considering hedging, and respondents cite U.S. tariff/policy risks as drivers of currency risk; roughly 25% of funds are using AI in FX processes with nearly a third exploring it.

Analysis

Market structure: Increased hedging intent (48% plan higher hedge ratios; mean hedge ratio 46%, tenor ~5.5 months) is a direct demand shock for forwards, NDFs and FX options — winners are FX interdealer desks, clearing venues and listed derivatives venues (CME), while unhedged asset managers and FX-sensitive EM/UK exporters face P&L pressure as hedging costs have jumped ~69% YoY. Higher deal flow and wider forward points boost fee income and margin capture for large banks and fintech providers that scale hedging operations; retail FX players and thin-market EM currencies will feel liquidity squeeze.

Risk assessment: Tail risks include a large fiscal surprise from the UK budget or a US tariff shock that moves GBP or USD by >3-5% in days, forcing mark-to-market and margin calls; immediate (days) risk is volatility spikes around policy announcements, short-term (weeks/months) is elevated hedging costs and basis volatility, long-term (2026) could be structurally higher hedge demand if managers permanently raise ratios. Hidden dependencies: swap-curve moves (BoE/Fed divergence) and prime-broker liquidity can amplify option/forward pricing; AI in FX may compress costs over 12–24 months but could increase model risk.

Trade implications: Tactical longs — listed derivatives/clearing (CME) and large FX-capable banks (HSBC/BARC) — should outperform pure exporters; buy 3–6 month GBPUSD ATM straddles to capture elevated implied vol ahead of BoE/Budget windows, scaling 0.5–1% portfolio exposure. Pair trades: long CME or HSBC (1–2% each) vs short unhedged UK exporters/EM FX-sensitive equities by 10–20%; options allowed to convert directional risk into defined-loss exposures.

Contrarian angles: Consensus assumes hedging demand will rise smoothly; it could be front-loaded into 1H26 and then normalize, creating short-term oversupply in options/forwards and compressing premia — a mean reversion opportunity. Historical parallel: post-2016 Brexit hedging surge reversed within 6–12 months; unintended consequence is that heavy hedging can increase market convexity and cause self-reinforcing moves in GBP during liquidity stress.

Key Decisions for Investors

• Establish a 1.5% long equity position in CME Group (CME) within 30 days to capture higher FX/interest-derivatives flow; target +20% in 12 months, stop-loss -12% (fundamental: higher volumes and clearing fees from elevated hedging).
• Buy 3-month ATM GBPUSD straddle sized to 0.5% of portfolio notional; enter ahead of major UK fiscal/BoE events or within 10 trading days, cap premium at <=1.0% of notional, take profit or roll if realized vol exceeds implied by >2pp or spot moves >1.5%.
• Initiate 1–2% long position in HSBC Holdings (HSBA.L) or Barclays (BARC.L) (choose the cheaper valuation) vs reduce unhedged exposure to UK exporters/EM FX-sensitive equities by 15% within 60 days; hold 6–12 months, take profits at +30%, cut losses at -20%.
• If UK budget delivers a fiscal shock >0.5% of GDP (announce/implementation within 7–30 days), buy 3–6 month GBP puts (2% OTM) equal to 0.5% portfolio notional — skew risk reward toward downside protection given potential >3% GBP moves.