Andrew Smith: Managing Currency Risk in Volatile Markets

Managing currency volatility
is a timely subject because investors now have
more choices available between purchasing
foreign investments in the local currency or hedge
back to their home currency. Currency policy helps you choose
which currency to invest in so that the currency
volatility of your investment aligns with your overall
investment objectives and risk tolerance. Recently currency volatility
has had a noticeable impact on investment returns. In particular, appreciation
of the US dollar versus foreign currencies
has eroded investment returns for dollar-based investors. Not surprisingly, when
currency volatility spikes so does investor concern. But many investor
discussions about currency stumble due to lack the
strategic currency policy adding complications
like partial hedging, tactical hedging, and the
episodic nature of currency volatility. And many currency
discussions end unresolved. Currency policy should
start at the portfolio level and take into account overall
investment objectives, time horizon, and risk tolerance. A strategic portfolio-level
currency policy provides the framework
for specific decisions about whether to purchase an
investment in local currency or hedge back to
your home currency. Here are a few of the factors
you should take into account. One important factor in your
portfolio currency policy is your time horizon. For short-term
assets it makes sense to match the domination
of your portfolio assets to the currency of
your current expenses. For longer-term assets, the
potential mean-reverting aspect of foreign currency
exposure becomes important. Incremental return may be earned
by combining foreign currency exposure with a regular
rebalancing policy. Your portfolio currency
policy should reflect your mix of short- and long-term assets. A portfolio currency
policy should also take into account the nature
of your home currency. For example, if your home
currency is a risk currency, your policy may be to have a
higher exposure to safe haven foreign currencies
which may diversify your exposure to domestic
market risk in times of crisis. It’s important to note
the tailored solutions can remove some uncertainty. As you can see, developing
a currency policy is not a one-size-fits-all exercise. Working with your adviser to
develop a strategic currency policy will enable you to
take advantage of the currency choices available to investors. The benefits are
worth the effort, insuring that during these
periods of currency volatility, your currency risk
is being managed thoughtfully and intentionally.

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