Strategic Asset Allocation and Currency Betas

Ross Kasarda and Steven Peterson

Investors supply liquidity to the market in exchange for returns that are proportional to their perceived exposures to various risk factors. The equity risk premium, for example, is the excess return over cash that compensates for risk associated with overall market volatility. In general, an asset’s beta to the market captures the systematic relationship between the returns on the asset and the broader market, and is therefore compensation for undiversifiable market risk.

Risk is typically synonymous with returns volatility, which itself is symptomatic of shifting exposures to underlying risk factors. As such, market volatility can be decomposed into risks associated with macroeconomic factors, such as growth, inflation, default and currencies. Moreover, various style premia commonly associated with factors including as value, carry and momentum can be thought of as compensation for risks embedded in the cross-section of returns. Thus, an asset allocation gains exposure to various betas across a range of risk factors and associated sources of risk premia. Investors that choose to optimise their portfolios may do so in order to diversify risks and returns across risk premia or