The cost of hedging is dependent on the prevailing interest rates in the relevant regions.
In the case of hedging US dollars back to sterling, the cost can be significant, due to the interest rate differential, with rates being substantially higher in the US.
This increase in cost may not be favourable over the long-term.
Globally diversified portfolio managers are typically taking a view on the prospective returns of a particular asset, including the currency impact, as part of a holistic assessment of an asset's properties and characteristics.
Portfolio managers considering their aggregate position will be looking at currency exposures and aiming to deliver a real return in their home currency, so will factor in foreign exchange risk as part of portfolio construction.
Lastly, and most importantly, we have seen that holding foreign assets and the associated currency impact that comes with it, can be a hugely beneficial diversifier.
Where your domestic market suffers, potentially dragging down asset prices, exposure to foreign currency can be a valuable form of diversification away from woes in an investor’s local region.
In that regard, while currency effects are an important factor for clients to be aware of, they can be considered both a valuable diversifier as well as a risk to be managed.
Currency hedging may have some value for advisers' clients with a need to preserve capital where they are facing an event risk with a binary outcome.
For instance, investors with a need to crystallise returns in the near future may wish to mitigate the risk that currency effects significantly alter the value of their portfolio.
This is particularly the case for government bond holders, with the assets generally serving a defensive purpose but representing an obvious currency risk since, by definition, the coupon on government debt is paid in the national currency.
Sacha Chorley is a portfolio manager at Quilter Investors
