Introduction
Investors should have a diversified portfolio of both assets and geographies as a basic rule of thumb. However, the more diversified a portfolio becomes the increasing number of considerations one must have. This is most acute when looking at currency exposure, and the perpetual questions around when and when not to hedge.
Understanding how currencies interact and how their performance can affect a portfolio is important, and merely recognising currency risk is not enough to protect from downside risk.
As currency markets move up and down based on monetary, fiscal and political events - understanding a portfolio's exposure has never been more important.
But how does a portfolio with an array of currency exposures react to different environments, and could such exposure actually increase diversification?
Furthermore, how does one value a currency and what factors should be taken into account when deciding if a currency is over or under-valued?
Such considerations are easier when studying developed market currencies, such as the dollar, sterling or yen. But as emerging markets, and in particular debt from such economies, become more popular, how do portfolio managers contain, or even benefit from, currency volatility?
