Although it is a risk exposure, it is not an economic asset for which a long-term premium exists. The annual foreign currency return has been about zero 0.

In the weak US dollar environment from to , US investors enjoyed a windfall as the foreign currency return contributed to the performance of international equities. The positive returns from foreign currency might have contributed to the unwillingness to address this uncompensated risk.

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Although there is no easy solution to address foreign currency exposures, institutional investors generally have these three choices:. The best solution will differ from institution to institution. The most important determining factors are the size of the foreign currency exposure and the base currency of the investor. Secondly, it boils down to the importance of risk relative to return, and cash flow management. In the following sections, we will address the available choices in more detail. Doing nothing is always the easiest option, but probably only makes sense for investors who have a relatively small exposure to foreign currency.

Unhedged foreign currency exposure can provide diversification benefits, particularly when the base currency of the investor is highly correlated to global equities. For example, Canadian and Australian investors benefit from unhedged US dollar exposure because the US dollar tends to appreciate in periods of equity underperformance. In general, hedging some or all of the foreign currency risk reduces the volatility of the portfolio.

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This freed-up risk budget can be redeployed more effectively by increasing allocations to compensated risk elsewhere. Yet passive hedging creates its own problems, including generating negative cash flow when foreign currencies are appreciating, and also detracting from returns due to hedging costs. This introduces a major market timing risk. If the base currency weakens after the change is implemented, the investor will suffer substantial hedging costs when the forward currency hedging contracts settle.

So, in our example, the investor will have to pay USD million during this period.

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Indeed, when experiencing this significant negative cash flow, some US institutional investors who used passive hedging liquidated their passive hedging programme at the worst possible time, as the US dollar bottomed in , after locking in significant losses on the short foreign currency forwards. Exhibit 2: Drawdowns in US dollar. Passive hedged: significant negative cash flows. One way to address the market timing risk of implementing a passive hedging programme is to delegate the timing of hedging the foreign currencies to a currency manager.

The active hedging programme seeks to reduce the risk of the foreign currency exposure, but varies the hedge ratios for the different currencies based on current market views to avoid negative cash flow and to generate positive returns. A successful active hedging programme should both add to the return of the portfolio and lower the volatility. Active hedging should not be confused with an absolute return currency strategy currency alpha.

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Such a strategy also seeks to generate attractive risk-adjusted return, but is not linked to any actual foreign currency exposure and should be gauged against a zero benchmark. Put differently, an investor does not have to have any foreign currency exposure to invest in an absolute return currency alpha programme. Our commodity indexed transaction team OTC group and commodities futures team are positioned globally to provide risk-management, investment and underlying solutions across all commodity derivatives. Providing liquidity for primary issues and secondary flows, BNP Paribas has more than credit traders operating from 10 trading hubs worldwide, supporting clients across a variety of credit disciplines, including research and strategy, origination and syndication, sales and trading.

BNP Paribas Equity Derivatives also provides appropriate and innovative investment and hedging strategies in equity markets across the globe, as well as financing solutions. With over 1, front-office staff across five platforms, the business is active in both the primary and secondary markets. Operating in all major trading hubs, we offer sales, trading, research, strategy, prime brokerage and electronic capabilities.

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BNP Paribas is recognised as a leading bank with a truly global reach within the interest-rate and inflation markets. With more than dedicated interest-rate professionals spread across strategy, trading, structuring and sales, BNP Paribas offers a complete suite of rate products from vanilla flow and structured products to hybrids. BNP Paribas offers a complete range of proprietary indices and strategies across commodities, credit, equity, FX and rates, as well as alternative and multi-asset indices. Clients can also access a wide range of products linked to the performance of our indices — from delta-one to structured products via swaps and options, with solutions on both the asset side and the liability side.

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The Market Economics team of experts offers real-time, in-depth analysis of the fundamental economic questions affecting your business. From interest-rate, growth and inflation forecasts to local market happenings around the globe, we offer client-oriented insight into the events shaping the world economy. BNP Paribas provides you with an extensive range of post-trade services that ensure full transparency when evaluating your investments across the different capital-market asset classes.