2016 promises to be challenging for U.S.-based pension plan sponsors and other institutional investors. We expect markets outside the United States to offer better investment opportunities and valuations this year than domestic markets will offer. However, U.S. investors who seek to capitalize on these opportunities need to consider the currency impacts associated with building a global portfolio when making asset-allocation decisions.
Traditionally, few U.S.-based pension plan sponsors have paid much attention to the impact of currency risk on their portfolios. Many have taken a passive approach and deferred to their portfolio manager on all foreign exchange (FX) risk management decisions. But the trend in currency risk is toward increased volatility. Currency risk is an overwhelming source of volatility for global fixed income, and the currency risk associated with global equity exposure is a meaningful contributor to total investment risk.
This isn't a problem corporate pension plan sponsors can expect to go away. If currencies are as volatile as expected, failure to effectively manage FX risk will potentially introduce uncompensated volatility into a plan's asset portfolio, which will reduce the expected efficiency of the investments.1
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