Business Spectrum✨
FOREX
Foreign Exchange Market
The foreign exchange market is a global, decentralized, or over-the-counter platform for currency trading. It sets exchange rates for all currencies and encompasses all activities related to buying, selling, and exchanging currencies at prevailing or predetermined prices.
FX Currencies
Currencies can be complex, and we believe that taking on FX risk does not provide rewards over the medium to long-term investment horizons for most investors. We view FX as a portfolio risk that requires thorough evaluation and management, rather than an opportunity for generating extra returns.
Why hedge? Since there is no clear return advantage over time, the primary goal for many long-term investors is to reduce volatility. Currency fluctuations can significantly increase the volatility of portfolio holdings, especially for low-yielding fixed income assets.
Key Highlights
The impact of currency risk is smaller for equities compared to overall portfolio risk, but it still plays a significant role. Currency risk notably contributes to the volatility of eurozone and UK equity portfolios. However, Japan is an exception due to the yen’s tendency to move counter to the domestic stock market.
We recommend that investors hedge the majority of their FX exposures in major developed markets (DM). We suggest fully hedging fixed-income allocations while leaving a portion of equity holdings unhedged, particularly for European investors. We provide our preferred hedge ratios for typical portfolios and emphasize the benefits of permanent hedges over attempting to dynamically adjust FX exposures.
While we see some potential for taking FX risk in the short term, it’s important to remember that the liquid, 24-hour currency market often reacts first to unexpected events. We highlight key drivers of currency movements: policies influencing interest rate differentials, investor sentiment, technical factors, valuations, and economic fundamentals.