In The Cost of Not Hedging Foreign Currency, the first paper on currency in a series of three, we introduce the potential issues created by foreign currency exposure embedded in international assets. We then analyze how hedging, the simplest form of currency management, has historically impacted portfolios.
- The portfolio of foreign currency exposure embedded in international assets is naively determined by the market capitalization of those assets, rather than being based on insight into the currency market.
- We believe that the embedded currency in a typical international asset portfolio should be treated as a form of uncompensated risk, and investors should consider a range of different approaches to mitigate that risk.
- A simple hedging strategy may be an important first step to managing currency risk.
- In upcoming papers, we will cover more sophisticated solutions, which allows investors to gain exposure to currency market risk in both passive and active ways.