Understanding Currency Exposure: A New Approach
Sponsored by Russell Investments.
BY Ian Toner | January 18, 2011
Most institutional investors have significant exposure to international assets: few institutional investors hedge the currency exposure that this entails. While institutional investors typically believe that this currency exposure has little long-term effect, the reality is that it can be seen as a significant concentrated bet on the behavior of their domestic currency. In fact, for many institutional investors, this single bet on the relative strength of their domestic currency can be seen as the single largest unmanaged bet in their portfolio.
Despite the size and nature of this significant currency exposure, U.S.-based investors have typically spent little time and focus on managing it while other investors, where there is a higher propensity to hedge, tend to use relatively simple approaches to the question of currency exposure. The techniques that U.S. investors use point toward a conclusion that there is no need to hedge currency exposure. Investors typically then consider whether it may be appropriate to hire an active currency manager to provide what is described as “alpha.”
Recent thinking about the tools and concepts involved, both within Russell and in the academic research community,1 has led Russell to begin to reconsider some of these conclusions, and then to reconsider some of the appropriate behaviors the investor may adopt, as well as the scale and nature of the benefit the investor can potentially reap by doing so. This has led us to reassess:
What currency risk is;
- How investors can think more effectively about currency exposure;
- How investors can develop a new “grammar” around currency exposure;
- and How currency risk (correctly defined) can be included in a global portfolio.
This new framework has led us to question many of the traditional assumptions about currency. The proposed implementation solution is referred to as Conscious Currency, and may drive significantly better returns for investors. Download the full paper.