Forex
Foreign Exchange Market
The foreign exchange market, also known as Forex, is a global, decentralized market where currencies are traded. It sets the exchange rates for all currencies and encompasses the buying, selling, and exchanging of currencies at current or predetermined prices.
FX Currencies
Currencies are complex, and we believe that taking on FX risk offers little reward over medium to long-term investment horizons. Instead of viewing it as an opportunity for additional returns, we see FX risk as a factor that requires careful analysis and active management.
Why hedge?
Since currency movements can significantly increase portfolio volatility, particularly for low-yield fixed-income assets, many long-term investors aim to reduce this risk. Without a clear long-term return benefit, hedging becomes a key strategy to stabilize portfolio performance and mitigate unnecessary fluctuations.
Key Highlights
Currency risk has a notable impact on portfolio volatility, particularly in eurozone and UK equities, though the effect is less pronounced than in overall risk. Japan is an exception, as the yen often moves inversely to the domestic stock market.
Our Approach to FX Hedging
We recommend that investors hedge most of their foreign exchange (FX) exposure in major developed markets (DM). Specifically, we advocate for fully hedging fixed-income allocations while maintaining partial hedges on equity holdings, particularly for European investors. Our strategy emphasizes the use of permanent hedges rather than attempting to dynamically adjust FX exposures, as it offers greater consistency and predictability.
Opportunities for FX Risk
While we prioritize hedging for stability, there is room for short-term FX risk-taking. Given that the FX market operates 24/7 and is often the first to react to unexpected events, investors can capitalize on these movements. Key drivers of currency fluctuations include policy changes affecting interest rate differentials, investor sentiment, technical factors, valuations, and broader economic fundamentals.
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