Currencies are volatile. Most US institutional investors have traditionally ignored this volatility in their portfolios, leaving a meaningful risk exposure unhedged. This practice puts American institutional investors five to ten years behind UK, European, and Canadian investors, who have generally managed foreign-currency risk proactively through hedging (given significantly smaller home country market capitalizations). Despite increasing sophistication, as US institutional investors have embrace alternatives, utilized risk budgeting, and generally raised allocations to foreign investments, currency exposure has largely been ignored, resulting in a meaningful risk allocation without positive return expectations.
A risk budgeting approach can identify sources of risk within a portfolio. When foreign asset classes and their underlying currency exposure are separated, risk budgeting reveals that developed foreign currencies are a volatile exposure within a diversified portfolio, adding risk without any increase in return expectations.