Insight Emerging Market Currency Diversification Strategy

At Insight, we believe that emerging market currencies behave differently to developed market currencies and so warrant a different currency risk management approach. Whilst it is broadly acknowledged that there is no reason to expect one developed market currency to appreciate versus another over the longer term, there are economic reasons to expect emerging market currencies to appreciate relative to developed market currencies over time. Our strategy acknowledges that one of the key objectives of investing in emerging market bonds and equities is to gain strategic exposure to emerging market currencies, to capture the valuation gain in the underlying currency as productivity improvements and demographics feed into higher GDP. Because this currency return is an attractive additional risk premium investors have tended to choose an unhedged benchmark.

However, for Australian dollar based investors their actual experience has been less than satisfactory with emerging market currency exposure actually detracting from the performance of the underlying assets over the past 20 years. We believe this is due to the strong economic linkages between Australia and Asia, in particular, which has resulted in a high correlation between the performance of the Australian dollar and the unhedged currency performance of the MSCI Emerging Markets Equity Index.

Our unique approach

  • maintains an unhedged strategic exposure to emerging market currencies
  • focuses on managing the short exposure to the Australian dollar, by diversifying this short exposure across the most liquid developed market currencies

As shown in the graph below this approach results in a substantial reduction in the overall currency risk, whilst also improving the returns, leading to greater confidence that the emerging market currency risk premium will be captured by the investor.

Monthly distribution of effective currency returns

Monthly distribution of effective currency returns chart

The Emerging markets currency diversification strategy is available to Australian institutional investors seeking to manage their currency translation risk as a result of investment in emerging markets equities and bonds. The strategy is managed in an unfunded individual currency overlay mandate by Insight’s highly experienced and resourced Currency Solutions Team.

Please refer to the links above for our latest performance in 'Fund and strategy updates' and a research paper outlining the development of our strategy is available in 'Recent thinking'.

Team statistics as at 30 June 2018. Assets under management (AUM) are represented by the value of cash securities and other economic exposure managed for clients. Fund size as at 30 June 2018.

Important information

The value of investments and any income from them will fluctuate and is not guaranteed (this may be partly due to exchange rate fluctuations). Investors may not get back the full amount invested. Past performance is not a guide to future performance.

Investments in emerging markets can be less liquid and riskier than more developed markets and difficulties in accounting, dealing, settlement and custody may arise.

Currency hedging techniques aim to eliminate the effects of changes in the exchange rate between the currency of the underlying investments and the base currency (i.e. the reporting currency) of the portfolio. These techniques may not eliminate all the currency 

Where model or simulated results are presented, they have many inherent limitations. Clients’ actual results may be materially different than the results presented. Model results shown reflect the reinvestment of dividends and other earnings but do not reflect management fees, transaction costs and other expenses that would reduce returns.

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