9 July 2026
Rodolphe Bohn
Currencies and Commodities Strategist, HSBC Private Bank and Premier Wealth
Willem Sels
Global Chief Investment Officer, HSBC Private Bank and Premier Wealth
Key takeaways
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Every overseas asset carries an implicit currency position that affects both risk and return. Managing foreign exchange (FX) exposure is therefore an important part of portfolio construction.
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We consider FX as an asset class because of its scale and liquidity, return relevance, diversification potential and trading infrastructure.
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Hedging can be implemented through asset allocation. Understand the differences between active and passive currency management, and how they work to manage currency risk.
Currency exposure is unavoidable when you hold assets outside your home country (e.g. US stocks and overseas property) or foreign-currency-denominated assets onshore (e.g. USD deposits). That creates extra opportunities, but also additional risks. If managed deliberately, FX can be considered as an asset class with its own return drivers, diversification properties and risk management tools. Even if you don’t trade currencies directly, FX will still affect your returns as exchange rates move. That’s why it’s important to manage FX exposure in portfolios.
What is FX in a portfolio?
Foreign exchange (FX) is the exchange of one currency for another. Exchange rates are quoted as currency pairs. The first currency is the base, and the second is the quote (counter) currency. For example, EUR/USD at 1.14 means one euro purchases 1.14 US dollars. FX enters a portfolio through:
Embedded exposure: you hold foreign currency because you own overseas assets or onshore assets denominated in a foreign currency.
Intentional exposure: you choose to change or manage currency risk through hedging, forwards, or an active currency overlay.
When the exchange rate moves, the home-currency value of a foreign asset changes even if its local-currency price is unchanged. For example, a local investor buys a US equity fund which returns 10% in US dollar terms over the year. If the local currency strengthens by 8% against the USD over the same period, the return falls to approximately 2%. Conversely, if the local currency weakens by 8%, the return will rise to approximately 18%.
Four criteria for defining FX as an asset class
Scale and liquidity: According to the BIS Triennial Survey, average daily FX turnover was about USD9.6 trillion in April 2025. Major G10 pairs typically trade with deep liquidity and tight spreads.
Return relevance: Currency movements can materially affect the home-currency returns of global assets.
Diversification potential: Currencies often have low correlation with stocks and bonds in the long run, helping diversify portfolios but correlations can increase during volatile periods.
Trading infrastructure: FX exposure can be accessed through spot, forwards, swaps and options.
Three strategies to generate returns
Carry: Borrow in a low-interest rate currency and invest in a high-interest-rate currency to earn the interest-rate differential. High-yielding currencies often do not depreciate as fast as expected. When global risk appetite deteriorates sharply, carry positions tend to unwind rapidly.
Value: Take exposure when a currency appears “cheap” or “expensive” versus long-run measures, such as purchasing power parity, on the expectation that misalignments may correct over time.
Momentum: Take exposure in the direction of recent FX trends, exploiting the tendency for exchange rate trends to persist over short-to-medium horizons.
FX in portfolio construction
FX risk already exists in your portfolio if it has any global exposure. When you buy a US equity fund, you’re exposed to movements in USD against your home currency. Currency volatility can affect asset classes differently, and therefore, the decision on whether to hedge depends on what you are investing in.
Bonds: Currency volatility is a key factor for bond returns, particularly for investment grade government bonds where yields are modest. A 5-10% exchange rate move can easily erase or double a 2-3% annual yield. Therefore, the case for hedging foreign currency bonds is usually more compelling than for other asset classes. However, in some cases, high hedging costs can eliminate returns.
Equities: The higher inherent volatility of equities means currency fluctuations typically represent a smaller share of total return variation. It may appear reasonable to leave equities unhedged for a longer investment horizon as incremental hedging cost is significant, but this will also increase currency concentration risk (particularly USD for globally diversified investors). For shorter investment horizons, however, currency movements can be a meaningful source of return volatility.
Alternatives: For low-volatility alternatives, such as infrastructure and real estate, currency movements can dominate returns, supporting the case for hedging. However, high-volatility alternatives, private equities and commodities typically carry enough return dispersion that currency volatility is a smaller marginal contributor.
The good news is that there are many options available to investors, through mutual funds or ETFs with embedded currency hedging policies. But even when you choose one of these options, it’s important to note that despite hedging, currency movements can still affect corporate earnings, margins and competitive positioning, potentially undermining equity performance. For bonds, they can feed through credit spreads, where issuers carry cross-currency liabilities. In other words, while hedging can remove the denomination effect, the underlying economic sensitivity remains.
Active vs passive currency management
Active currency management seeks to generate returns and reduce risks by taking deliberate currency views that deviate from a benchmark hedge ratio. This can go beyond the investor’s usual hedging ratio on currencies expected to depreciate, and vice versa for currencies expected to appreciate.
Passive currency management applies a rules-based hedge to a fixed proportion of foreign currency exposure (the hedge ratio). A 100% hedge ratio means fully hedged back to the base currency; 50% means half hedged. An investor simply hedges or accepts currency exposure without attempting to add value beyond risk reduction.
Conclusion
For any investor who holds assets outside their home currency, FX exposure already exists. The only question is whether it is managed deliberately or left to accumulate by default. The following rules of thumb may be helpful as a starting point:
Identify your embedded exposure: Understand the currency composition of your portfolio before considering any active management. Most investors have concentrated USD exposure due to the big share of the USD in global equity and bond markets.
Consider hedging fixed income before equities: Currency volatility is likely to dominate bond returns, reinforcing the case for hedging, while higher underlying volatility means the decision is more nuanced and horizon-dependent for equities.
Decide how much currency risk to take: FX overlays require little or no additional capital. The key decision is how much currency risk your portfolio should take, in line with your overall risk tolerance.
Combine multiple FX strategies: Carry, value and momentum perform well under different market conditions. Rather than relying on a single strategy, combine all three to diversify your sources of return.
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