Managing Currency Risk in a Two-Speed World

June 2017

Today’s climate raises new FX-related headaches for investors, provoking a rethink of historic decisions to hedge currency risks, leave them unhedged or delegate to fixed income and equity managers. Active currency overlays appear to be increasingly popular.

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Active currency overlay strategies fall into two main families: dynamic hedging and multi-strategy. The latter offers a more all-weather approach but greater complexity.

Analysis of active currency overlay managers should be highly customised to the investor. As illustrated in a “DNA of a Manager Search,” portfolio-specific performance outcomes, regional reporting requirements and fit with other providers such as custodians must be considered.

Transaction costs are highly significant in both active and passive currency management. Conventional methods for assessing these costs are highly flawed. Managers shortlisted in the case study here had average t-costs ranging from 0.46bps to 2.68bps while management fees were also highly dispersed.


Although 2017 is too early to predict a return to the heyday of active currency management, active or tactical approaches to managing currency risks are becoming more popular.

Influential new trends include: the emergence of a ‘two-speed world’ as interest rates in the US and Europe diverge; more frequent geopolitical macro events, which have boosted FX volatility; greater scrutiny of currency management costs (both passive and active) in a fee-conscious climate, with the anticipation of more stringent transaction cost reporting requirements under Mifid II.

This paper offers an examination of a sub-sector where we have observed increased appetite: active currency overlays, the hybrid blend of hedging and modest active return targets.

A DNA of a Manager Search explores one pension fund’s hunt for solutions. This reveals a universe of providers that has changed significantly, key distinctions in strategy and massive disparities in both visible and invisible costs. Transaction Cost Analysis (TCA) formed a particularly vital aspect of the process, with the assistance of independent specialist New Change FX. Far from being a dry technical afterthought, smart execution is increasingly recognised as one of the key areas where providers can add value.

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