CURRENCY MANAGEMENT
helping to meet the challenge of currency market risk
Conscious Currency : TM
Over the last 20 years investors have steadily increased their exposure to international assets. This increase has brought with it greater exposure to currency risk. This currency exposure FDQ EH D VLJQLÀ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risk. He outlines three possible ways to think about currency exposure and why investors should also think of the currency risk derived from unhedged international investments as though it were the result of holding an unfunded currency portfolio.
can have a material impact on investment returns, and that the currency markets are both volatile and GLIÀFXOW WR SUHGLFW
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What makes it worse is that exchange rates are just that – rates at which one thing of the same type can be exchanged for another. In other markets investors can think of prices in natural terms (the price of one share of IBM is a certain number of U.S. dollars), but currency markets are different –you’re exchanging one currency for another. One currency “going up” is identical to the other “going down.” That’s a different way of thinking from the day-to-day analysis that investors do, and quite unlike the stock example, as we don’t think of an investor who’s buying IBM stock as someone who is “selling dollars,” even though that’s technically correct.
So currency risk is volatile, unpredictable, confusing, and requires that investors adopt a different way of thinking from the normal approaches for most asset
urrency has risks. That’s a simple statement that won’t surprise most investors. They understand that changes in exchange rates
classes. This problem is only likely to get worse. It seems like we may be moving towards a more unsettled world, with greater economic pressures, more complex political pressures, and challenging GHPRJUDSK\ FUHDWLQJ VLJQLÀFDQW HFRQRPLF GLIIHUHQFHV between regions and countries. At the same time JUHDW XQFHUWDLQW\ RYHU LQÁDWLRQ DQG GHÁDWLRQ ZLWK increasing focus on the money-nature of gold, and greater exposure to commodities combine to make exchange rates (often the lynchpin and transmission mechanism of all of these issues) a larger part of the picture than has been the case over the last 20 years. In retrospect the 20 years just gone appear a time of convergence and relative stability.
It’s not a huge surprise then that discussions about currency are not most investors’ favorite thing. It’s more interesting and comfortable to spend time GLVFXVVLQJ ZKLFK PDQDJHUV WR KLUH RU ÀUH RU WR spend time talking about long-term economic and market forecasts. Understanding the nature and behavior of funding liabilities can be complicated, but is at least based upon relatively simple concepts that most investors can grasp. When currency is
Autumn 2011 | Currency Investor 23
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