Plugging The Leakages In The Implementation Of Currency Hedging

Executive Summary

Buy-side firms often separate the management of currency risk from asset allocation and security selection decisions and therefore manage currency hedging implementation as a separate operational process. This can result in implementation blind spots. Most buy-side firms focus their efforts on optimizing the hedge ratio and strategy decisions based on forecast movements in exchange rates, valuation, interest rate differentials, and other perceived risk factors.

The sell-side's focus on spot forecasting, minimization of self-executed spot transaction costs, targeting hedge funds, and high turnover speculators have resulted in blind spots and leakages in the buy-side implementation process that could be mitigated through a better understanding of currency as a risk asset class. This article highlights critical implementation and risk considerations that are often misunderstood by buyside firms in fulfilling their fiduciary responsibilities.