Article by Michel Charron, Investment Analyst at PBI Actuarial Consultants Ltd., published in the Benefits and Pensions Monitor Online (BPM).
Currency issues for institutional investors
It has already been over a decade since changes in foreign investment regulations have allowed Canadian pension plans to increase their proportion of assets in global investments. This increase in foreign asset exposure has led to greater exchange rate risk for international investors, resulting in a wider discrepancy between assets and liabilities for Canadian pension plans that pay benefits in Canadian dollars.
Investors have three options at their disposal with regards to their foreign investments:
- Receive the local currency return on their foreign investments plus the changes in exchanges rates;
- Hedge the currency risk/return;
- Actively manage their currency exposure.
Investors that have international portfolios need to consider the impact of changes in exchange rates on their domestic return and the contribution of currency risk to their total portfolio risk. If a decision is taken to hedge an international portfolio against the effects of changes in exchange rates, the volatility of unhedged vs. hedged returns should be considered. Depending on whether the investors would like to fully or partially hedge the portfolio, an optimal hedging ratio should be determined.
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