Managing Developed-Country Currency Risk
Investing in international equities introduces two primary risks to an investor’s portfolio: currency risk and equity risk. As such, investors should consider disaggregating these risks when evaluating foreign investments. Analyzing the total return of foreign investments without comparing asset returns and currency returns separately conceals any impact to the portfolio from holding foreign-currency exposure.
Yet despite the growing interest in foreign investments, many investors haven’t prioritized managing embedded currency risk, which may introduce unintended exposure and volatility. Parametric’s view is that investors should make an explicit decision of how much foreign currency exposure to carry and reflect this decision in their asset allocation.
This paper examines the diversification benefits foreign currency exposure offers, the benefits and costs associated with hedging against currency risk, and the implementation considerations.