How should a portfolio manager approach currency management in a global portfolio?

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AcadiFi · Accepted Answer

Currency management in global portfolios starts with a strategic policy decision: what is the portfolio's base currency, and what role does currency play in the risk-return profile? Three archetypes exist. Fully hedged — remove currency risk entirely, suitable for short-horizon investors or liability-matched pools. Unhedged — accept currency exposure for its diversification benefits or expected returns, typical of long-horizon equity investors. Strategic partial hedge — institutional default, often 50% hedge on developed market equities. Decision inputs: (1) investor's objectives (nominal vs real, horizon); (2) liability nature (matched currency vs. diversified); (3) regret aversion (clients hate watching hedges lose when foreign currency rallies); (4) cost of hedging (interest rate differentials via covered interest parity); (5) correlation benefits (foreign currency often negatively correlates with foreign equity in risk-off episodes). For a US pension with Brindlemoor Global Equity exposure of $800M in EAFE, partial hedging of 50% reduces volatility by ~2% while preserving some natural hedge in downturns. Implementation choices include forward hedging (rolling monthly), currency overlay managers, and passive hedging benchmarks. The IPS should specify policy hedge ratio, rebalancing tolerance, and discretion granted to overlay managers. Active currency views layered on top (carry, value, momentum signals) require separate risk budgets.

How should a portfolio manager approach currency management in a global portfolio?

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