investment insights
The benefits of currency diversification: strategic FX benchmarks, tactical allocation, and tailor-made solutions
Key takeaways
- Foreign exchange rate risk matters and is too big to be ignored
- This risk can be mitigated via the use of FX strategic benchmarks…
- … while risk-adjusted returns can be improved via tactical FX management
- FX benchmark customisation to personal circumstances is also very important.
Investors typically have a significant share of their wealth allocated to foreign assets. While ‘home bias’1 remains a feature in investment decisions – for example, Swiss investors allocate around 44% of their equity exposure in domestic stocks2– foreign asset ownership remains significant. This is because of the diversification benefit and desire to explore more uncorrelated return opportunities outside the borders of the home country.
Investing in foreign assets naturally comes with currency risk. In this white paper, we discuss various approaches to address this risk. We argue that exchange risk matters and is too big to ignore. We then explore hedging strategies and conclude that, depending on the asset class involved, some currency hedging is required to mitigate or reduce unintended sources of risk to portfolio returns.
Strategic Asset Allocations (SAAs3) are simple benchmarks that take into account several medium- to long-term factors when constructing a strategic portfolio’s appropriate FX exposure. Their use provides a substantial improvement compared with completely ignoring exchange rate fluctuations. The result can be improved further by tactical currency management, in other words by moderate short-term deviations from the FX benchmark’s weights, in order to profit from cyclical opportunities.
Alas, one size does not fit all. Investors have different risk tolerances, priorities, plans as well as currency exposures via various forms of investments, such as foreign real assets. This can create mismatches between assets and liabilities or in cash flows, which need to be addressed by ‘customising’ the currency benchmark. We provide a simple framework for assessing specific needs, and discuss a number of examples that can help investors reap the benefits of custom-made FX benchmarks.
1 Home bias refers to the tendency of investors to allocate a significant portion of their wealth in domestic assets
2 Source: Vanguard Research, December 2014
3 We will use these terms interchangeably throughout
Wichtige Hinweise.
Die vorliegende Marketingmitteilung wurde von der Bank Lombard Odier & Co AG (nachstehend “Lombard Odier”) herausgegeben. Sie ist weder für die Abgabe, Veröffentlichung oder Verwendung in Rechtsordnungen bestimmt, in denen eine solche Abgabe, Veröffentlichung oder Verwendung rechtswidrig ist, noch richtet sie sich an Personen oder Rechtsstrukturen, an die eine entsprechende
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