Separating Currency Returns from Asset Returns in Theory and Practice: Conscious Currency and Beyond

Ian Toner

This chapter will suggest that the existing approaches investors take towards currency exposures are flawed. It proposes that investors should adopt an approach to describing, understanding and managing currency exposures which is more consistent with the rest of the portfolio management process, and that provides investors with the opportunity for more sophisticated portfolio construction.

In particular, the following three elements are proposed.

• Investors should always separate the currency dimension of investing from the asset elements of investing. This means they should use asset class benchmarks that are hedged into their home currencies at every stage in the investment process: from asset allocation and policy portfolio construction, through manager selection and appointment to attribution analysis and performance measurement. Investors should not view currency through a lens of hedging existing exposures that come about through the use of unhedged benchmarks.

• Investors should recognise that the currency markets exhibit structural risk and return characteristics that can be described using standardised investible benchmarks, and that certain of these benchmarks