To paraphrase the father of macroeconomics, John Maynard Keynes: When the market environment changes, my portfolio currency allocation changes … what do you do?
In recent years, the U.S. dollar experienced one of its longest and largest rallies since floating exchange rates began in the early 1970s. Given the uncertainty in the outlook for U.S. interest rates and the path of the U.S. economy after the presidential election, the outlook for the U.S. dollar is far less clear than in the prior three years. In this environment, how should pension fund chief investment officers think about the issue of managing foreign currency exposure?
Historically, there exist two schools of thought about how to deal with currency risk in international portfolios. The first is to do nothing and leave all currency exposures unhedged. The second is to hedge it away and eliminate currency risk from the portfolio entirely. These two competing approaches are founded on several core beliefs that have questionable foundations.