A fresh look at currency

Investors should think about currency risk as might approach a dessert menu, according to the head of currency implementation with Russell Investments.

“When we talk about currency, it’s like we’re talking about pie,” said Ian Toner, speaking at the recent Pension & Benefits Summit in Toronto. “The problem with currency is, you need to know what’s in the pie before you know whether you want it or not.”

The questions for an investor are, ‘Do I want currency exposure? If I want that exposure, how much do I want and what type?’ According to Toner, there are three ways to think about currency:

• Currency is random; it doesn’t matter how much currency you’re exposed to or what currencies are in the portfolio. “Okay, you don’t need to worry about it, but you’ll have to be happy with 100% exposure one day and 0% the next, and be comfortable with all of your currencies in rubles one day, yen the next day.…”
• What currencies you’re exposed to doesn’t matter, but the amount of exposure does. “That’s the hedging conversation. That’s how big a slice of pie, but I don’t care if it’s steak and banana pie.”
• The amount of exposure and what that exposure is matters. Toner said the traditional approach to this thinking is to hire a hedge fund or adopt an active investment management strategy. But he offered an alternative, which Russell Investments calls “conscious currency.”

This is a framework for a “different conversation” about what currency exposure is. And this means “don’t sleepwalk” through this, Toner said, adding that this is large exposure, with big volatility, and can give you good and bad outcomes.

But how do you measure currency? Toner recommends you pick a benchmark that describes currency in its own terms—not based on your equity exposure, or on the fixed income market.

Decide how much exposure you want to that benchmark, and use the portfolio management processes that you use today, he continued. “Use [currency] as though it were an asset class.” Toner pointed out that this [strategy] gives you that middle-ground exposure to currency.

“Banana-and-steak pie sucks—even with ice cream,” he joked. “And, at the moment, pretty much every investor has got a big heaping portion of banana-and-steak pie.”

But if you don’t like steak-and-banana pie, you should rethink currency in terms of what you’re exposed to and the amount of exposure.