• Adding foreign currency exposure to an equity portfolio increases the volatility of portfolio returns
• In recent times, the correlation between foreign currencies and equities has become positive for U.S. investors and this has made the volatility increase greater still
• The long-term expected return of embedded developed market currency exposure is zero; however, embedded currency exposure can have a substantial impact on returns, sometimes of a magnitude greater than that of the underlying asset returns
In creating an appropriate currency risk management policy, investors need to consider the following questions to guide them:
1. What is the size and nature of the risk created by leaving foreign currencies unhedged?
2. What is the reward for this risk?
3. What is my strategically neutral currency position, at the portfolio or asset class level?
4. Which currency exposures do I want to hedge (if any), and how much to hedge?
5. Is my hedging strategic or tactical?
6. Should I hedge passively or use an active approach to managing currency risk?
7. Who will manage cash flows arising from a currency hedge?
8. Who can easily and clearly measure and demonstrate results to me?
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