“You all have currency,” said Andrew Harrex, managing director of P/E Investments. “If you invest overseas, you are already investing in currency. Most just don’t think of it that way.”
Speaking at The Inside Network’s Alternatives Symposium, Harrex challenged advisers to reconsider how they view international exposure. “Think of your global equity portfolio. It’s actually two portfolios,” he said. “There’s the underlying equities, and then there’s the currency. On average, 30 per cent of your total equity return comes from currency.”
That currency exposure, he argued, is too important to leave unmanaged. “You are allocating 18 per cent to equities and 7 per cent to global currencies, not 25 per cent to equities,” he said. “That’s just the data. My question is: what are you doing about it?”
What most clients want, Harrex said, is not simply diversification, but true downside protection. “People say they want uncorrelated assets. But what they really want is something that’s negatively correlated when equities fall. Isn’t that what they actually mean?”
The data bears this out. Looking at six equity drawdowns over the past 25 years on the ASX, Harrex compared how various asset classes performed during periods of 10 per cent or greater equity market declines. “Bonds haven’t consistently protected portfolios. Private markets, trend-following, gold, none gave reliable downside protection.”
The standout was currency. “The average equity drawdown across those six periods was 20 per cent,” Harrex said. “Our active FX strategy returned 13 per cent across those same periods. That’s a downside capture ratio of 66 per cent.”
For advisers searching for protective assets that do not erode long-term returns, that is a compelling case. “There is no perfect asset, only put options give you perfect protection,” Harrex said. “But currency was the best-performing asset in down markets. And over the full cycle, it gave you equity-like returns.”
The rationale is straightforward. “This active FX strategy is essentially a global macro strategy,” he explained. “It picks up on macro themes, and there’s always a reason why equities fall. This gives you a better chance of protecting the portfolio when they do.”
It also addresses a growing structural issue. “The historical bond-equity correlation has broken down,” Harrex said. “For 25 years, bonds offered negative correlation. But since 2020, it’s flipped. Now the correlation is positive.”
That shift has profound implications. “We looked at inflation levels,” Harrex said. “When US inflation is above 2.5 per cent, the bond-equity correlation is positive. When it’s below 2 per cent, it’s negative. Our view is inflation is going to stay high. That positive correlation is here to stay.”
In light of that conviction, Harrex believes FX deserves a seat at the core of portfolios. “One of our clients described it as positive-carry portfolio insurance,” he said. “I like that. Because it tends to go up when equities go down, but unlike traditional insurance, it doesn’t cost you each month.”
He illustrated this with a reallocation of a standard 60/40 portfolio. “We replaced 20 per cent of the bonds with our FX strategy,” he said. “That shift increased annual returns by 1.2 percentage points, with the same volatility. A better portfolio by every metric.”
For those using private assets, the argument still holds. “We added a variety of private assets to the mix and ran the efficient frontier,” Harrex said. “Then we added FX. Not only did it move the frontier up and left – lower volatility, higher return – it blended better with other assets than almost anything else.”
The final takeaway? Advisers must think beyond Sharpe ratios. “Sharpe is about reducing volatility,” he said. “Bonds have the best Sharpe ratio, but is 100 per cent bonds what your client wants? Probably not. The Sortino ratio, which focuses on downside protection, tells a more relevant story for portfolios. FX ranks exceptionally well there.”
Harrex concluded with a simple request. “Throw away what you thought you knew about currency,” he said. “At least explore what active FX can do in a portfolio. See the difference for yourself.”