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Currencies are notoriously hard to forecast, and over the long term, their expected return is close to zero.¹ So, the purpose of a strategic hedging policy isn’t to generate alpha from currency views, it’s to reduce unintended risks in the portfolio and improve overall efficiency.

But reducing risk isn’t as simple as eliminating FX exposure. In fact, a fully hedged approach can sometimes increase overall portfolio volatility or dilute important diversification benefits. The optimal hedge ratio is rarely 0% or 100%. Instead, a thoughtful balance of asset class characteristics, correlation patterns, hedging costs and broader investment goals should be considered.

The right FX strategy hedging policy depends on what you’re investing in:

• For lower-risk assets like fixed income, currency swings can dominate the volatility profile. Hedging FX exposure on bonds often works because the underlying asset returns are relatively stable – and FX fluctuations can introduce unwanted noise. This is not a hard rule, however, depending on the end portfolio objectives and liabilities, holding some foreign currency may be beneficial.
• For higher-volatility assets like global equities, the story is different. FX tends to play a smaller role in total risk, and in some cases, foreign currency exposure can actually reduce risk. Currencies like the US dollar, Japanese yen, or Swiss franc often move in the opposite direction of equity markets during periods of stress. That means they can act as shock absorbers when volatility rises – offering natural diversification.

The critical question, therefore, is not whether currency risk matters, but what the optimal approach of managing it is?

Find out how the Partnership Solutions team is thinking about this question: