Currency movements can quietly erode returns that took years to build – and Toby Watson argues that too many investors still treat foreign exchange risk as an afterthought rather than a core portfolio consideration.
International diversification is widely accepted as a cornerstone of sound portfolio construction. Yet the currency risk that comes with it is frequently underestimated, mismanaged or ignored altogether. When exchange rates move sharply – as they have done repeatedly in recent years – the impact on portfolio returns can be dramatic, often dwarfing the underlying asset performance that investors were focused on in the first place. Toby Watson, whose career has taken him across financial centres in London, New York and Hong Kong, brings a genuinely global perspective to currency risk management that many investors would benefit from understanding.
Foreign exchange markets are among the largest and most liquid in the world, yet currency risk remains one of the least systematically managed factors in private wealth portfolios. For investors holding assets denominated in multiple currencies – whether through international equities, foreign bonds or alternative investments in overseas markets – the currency dimension can add or subtract meaningfully from total returns without any change in the underlying asset itself. The volatility of major currency pairs has increased noticeably in recent years, driven by diverging monetary policies, geopolitical tensions and shifting capital flows. Toby Watson has observed these dynamics closely and sees currency risk management as an area where rigorous analytical thinking can make a tangible difference to long-term portfolio outcomes.
Currency Risk and Why It Gets Overlooked
There is a straightforward reason why currency risk tends to be underweighted in portfolio construction discussions: it is invisible in calm markets. When exchange rates are relatively stable, investors focus on the assets themselves – the equities that are rising, the bonds paying coupons, the alternatives generating distributions. Currency sits quietly in the background, neither helping nor hurting in any dramatic way.
The problem is that this calm rarely lasts. Currency markets can reprice sharply and quickly, driven by central bank policy shifts, political events or changes in global risk appetite. When sterling fell sharply following the Brexit referendum, or when the US dollar surged during the 2022 rate hiking cycle, investors with unhedged foreign currency exposure felt the impact immediately. Toby Watson has consistently highlighted this asymmetry: currency risk is easy to ignore until it is not, and by the time it becomes visible it has often already done significant damage.
How Much of a Portfolio’s Return Is Actually Driven by Currency?
More than most investors realise. Studies of international equity portfolios have repeatedly shown that currency movements can account for a substantial proportion of total return variance over medium-term horizons. Toby Watson, who built his career at Goldman Sachs working across multi-currency capital markets and structured finance, has noted that the currency component of an international portfolio is a genuine source of risk and return in its own right – not simply noise around the asset return. Treating it as a residual rather than an active consideration is a structural weakness in many otherwise sophisticated portfolios.
How Toby Watson Approaches Currency Exposure
Toby Watson approaches currency risk through the same macro-driven analytical lens that shapes his broader investment thinking. The starting point is understanding the sources of currency exposure within a portfolio – not just direct holdings in foreign assets, but indirect exposures arising through companies with significant overseas revenues, commodities priced in dollars and alternative investments with multi-currency cash flows.
From there, the analysis moves to whether those exposures are intentional or incidental. An investor holding Japanese equities because they believe in specific companies’ long-term prospects has made a deliberate asset allocation decision. The yen exposure that comes with those holdings may or may not be a view they want to express – and conflating the two is a common source of unintended risk. Toby Watson’s years at Goldman Sachs, navigating currency dynamics across developed and emerging markets, reinforced a discipline of separating asset views from currency views rather than treating them as a single undifferentiated position.
Hedging Strategies and Their Practical Limitations
Currency hedging is the most direct tool for managing foreign exchange risk, but it comes with costs and constraints that vary considerably depending on the currency pair and investment horizon:
- Forward contracts allow investors to lock in an exchange rate for a future date, providing certainty but forfeiting any potential upside from favourable currency moves. They are most appropriate where the currency exposure is large, predictable and unwanted.
- Options-based strategies offer asymmetric protection – limiting downside from adverse currency moves while preserving upside participation. The cost varies with market volatility and can be significant during periods of elevated uncertainty.
Toby Watson has noted that the decision to hedge should flow from a clear view on whether the currency exposure is a risk to be managed or a return source to be retained. Hedging everything indiscriminately is as problematic as hedging nothing.
The Impact of Diverging Monetary Policy
One of the more significant drivers of currency volatility in recent years has been the divergence in monetary policy between major central banks. When the Federal Reserve tightened aggressively while other central banks moved more cautiously, the resulting dollar strength had real consequences for portfolios with significant non-dollar exposure. Toby Watson, drawing on his experience at Goldman Sachs across multiple tightening cycles, has pointed to this period as a clear illustration of why currency risk cannot be treated as static.
- Emerging market currencies are particularly sensitive to dollar strength, as many EM economies carry dollar-denominated debt and are vulnerable to capital outflows when US rates rise. Investors with EM exposure who had not accounted for this dynamic found their currency losses compounding their asset losses during the 2022 tightening cycle.
- Cross-currency basis – the cost of borrowing in one currency while lending in another – can shift significantly during periods of stress, affecting the economics of hedging strategies in ways not always apparent from headline exchange rates alone.
Toby Watson on Currency as an Active Portfolio Consideration
At Rampart Capital, where Toby Watson is a partner, currency exposure is treated as an active dimension of portfolio construction rather than a passive consequence of asset allocation decisions. This means maintaining a clear view on the macro drivers of major currency pairs, assessing the cost and effectiveness of available hedging instruments, and revisiting currency positioning as the macro environment evolves.
For investors managing wealth across borders, this kind of systematic attention to currency risk is not optional. Toby Watson’s experience across global capital markets has shaped a clear conviction: investors who manage currency risk well protect capital more effectively when conditions deteriorate – and that discipline compounds meaningfully over time.
