By Gavin Francis, Managing Director, Pareto Investment Management

Pareto Managing Director Gavin Francis explains how investors gain by distinguishing currency translation risk from currency alpha risk:

• Currency translation risk is a byproduct of foreign investment that has zero expected return, and may be hedged in a passive or active fashion. Currency alpha risk stems from active decisions by managers seeking to generate positive cash flow.
• Investors should develop a risk-budgeting hierarchy, which would include currency translation hedging policy in the first tier and currency alpha strategies in the second tier, along with other alternative investments.
• Active hedging is superior to the traditional approach, which assumes that hedging is a passive activity
• To optimize a currency alpha strategy, it should not be constrained by the currency exposures of the portfolio. The risk of active management can be reduced by diversification, either with multiple managers or a fund of currency funds.

For more information and a hard copy, please contact Neil C. Craig, Jr., at 212 527-1806 or neil.craig@paretopartners.com.

The preceding information is based upon the analysis of historical performance of various asset classes and assumptions with respect to future economic conditions. Past performance is not an indication of future results. This information is not intended to provide specific advice, recommendations or projected returns of any particular BNY Mellon Asset Management product.