| Currency overlay 101 |
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| 02/05/2004 | |
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In existence since the late 1980s, the currency overlay technique has carved out its own niche within the portfolio of many institutional investors as they became increasingly aware of the toll currency movements could take on their investment returns. But what is a currency overlay exactly: a technique, a strategy, or an asset class, or all of those? Two experts, Renaud Mattis, Senior Portfolio Manager at Overlay Asset Management, a BNP Paribas branch, and Paul Skinner, Head of Fixed Income Business Development at UK-based Gartmore, answer bfinance's questions about currency overlay. What is a currency overlay? Does it qualify as an alternative investment? Renaud Mattis, Senior Portfolio Manager, Overlay Asset Management Currency overlay is the management of currency risks embedded with international investments, foreign assets, liabilities or commercial flows. As any other strategic investment decision, currency overlay often implies that foreign exposure should be managed as a separate asset class with a process on its own. Although seen first as a service class, currency overlay exhibits risk-return features that can offer many similarities with alternative investments when underlying currency risks are no longer taken into account. If currency hedging – be it active or passive – is accepted as an alternative strategy to the do-nothing policy, then the traditional currency overlay can already be qualified as an alternative investment. It surely offers significant risk-reduction and or return-enhancement benefits to international portfolios over short- to long-term investment horizons. Finally, currency overlay has demonstrated its value added is not dependent of the performance of traditional asset classes. Paul Skinner, Head of Fixed Income Business Development, Gartmore Most institutional portfolios have foreign currency exposure caused by their foreign equity holdings and often this risk is left unmanaged. Currency overlay is the professional management of that currency risk in order to produce added value. Currency overlay is not an alternative investment; it is the prudent management of an existing risk in traditional asset classes. Why institutional investors should (or should not) include a currency overlay within their investment strategy? Paul Skinner: The Myners report suggested that UK pension funds should consider all the risks in their portfolio and examine how they should be managed. This is true for all investors. Currency is a risk source and should be managed. First off, the average currency manager produces healthy alpha at very high information ratios compared to other asset classes. This is because currency is both highly liquid (cheap to deal in) and the majority of investors are "non-profit maximisers" such as corporates and tourists. This provides an ideal opportunity for professional investors to profit. Second, the returns from currency have zero correlation with other asset classes such as bonds and equities. As part of a diversified portfolio currency adds return while lowering the total risk profile. Renaud Mattis: Investors should have a currency overlay because it is the first step toward a sound investment strategy. Indeed, foreign exchange movements significantly impact the risk profile of global portfolios. Besides, currency management is also a source for risk-adjusted returns. Finally, it is a benchmarked strategy on its own and can therefore be customized to specific investors' needs and issues. Interview by This e-mail address is being protected from spam bots, you need JavaScript enabled to view it |
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