Last week’s conveniently ‘leaked’ government proposal on its plans to revolutionise retirement income for all Australians has brought retirement back into the headlines. The detail aside, the proposal couldn’t have come soon enough.
What do you do when you finish high school? “Go with your strengths,” Peta Nunn’s school careers counsellor told her. So, she found herself in a maths degree at university. But something didn’t feel right.
Rethinking Diversification: Foreign Exchange as Portfolio Protection
As the equity-bond correlation has turned familiarly negative again – a 60/40 balanced portfolio performed well in 2024, mainly banked by global equities, while global bonds helped to dampen volatility as they eked out a small gain – many wary investors are not totally convinced; they are at least thinking about the search for a better diversifier.
Andrew Harrex, head of investment solutions at P/E Investments, argues that foreign exchange strategies could offer a compelling alternative. Speaking at The Inside Network’s Alternatives Symposium, Harrex pointed to historical data showing that traditional portfolio hedges, including bonds and trend-following strategies, have faltered in major market downturns. Meanwhile, FX strategies have consistently delivered strong downside protection.
The core issue is the cost of protection. Traditional hedging mechanisms, including options and structured products, often act as a performance drag in stable markets. Investors want security, but they’re reluctant to sacrifice returns. FX strategies, particularly active currency management, offer an alternative that provides insurance while maintaining positive carry.
Market data from past crises reinforces this view. During the Global Financial Crisis (2007-2009), the European sovereign debt crisis (2011), and the pandemic-driven selloff (2020), FX strategies outperformed bonds and trend-following strategies. This was particularly true for Australian investors, given the significant role of currency fluctuations in cross-border portfolios.
Harrex argues that the shifting macroeconomic landscape supports a rethink of the 60/40 portfolio model. With inflation stabilizing above 2.5 per cent and central banks engaged in quantitative tightening, the traditional assumption that bonds will cushion equity declines is increasingly questionable.
“I’m hearing from investors that they’re overweight equities because, in their view, equities are the only game in town,” Harrex said. “But at the same time, they’re increasingly nervous. They’re asking, ‘What can we do now to get some protection if the market turns south?’”
He pointed out that while traditional hedges like bonds are often perceived as an implicit hedge, recent history suggests otherwise. “We saw in 2022 that when equities went down, bonds went down as well. That was a classic example where bonds didn’t give you the protection you expected,” he said. “The research shows that when inflation is above 2.5 per cent, bonds tend to be positively correlated with equities, not negatively correlated. So the debate is whether bonds can still provide that implicit hedge.”
Harrex believes the answer lies in FX. “The obvious one for me is currency. Historically, it has provided that implicit hedge,” he said. “Our strategy and others like it have consistently shown that during down equity periods, FX strategies continue to play a protection role in the portfolio.”
P/E Investments’ analysis suggests that portfolios incorporating active FX exposure – whether at a 10 per cent, 20 per cent, or 30 per cent allocation – have historically shown improved risk-adjusted returns compared to the traditional 60/40 model. The firm’s data indicates that an FX overlay can reduce drawdowns while still benefiting from positive market trends.
One reason FX strategies perform well in downturns is liquidity. Unlike private market investments or even certain hedge fund strategies, currency markets remain highly liquid during crises. This allows for efficient risk mitigation without the liquidity constraints that can plague other asset classes.
Harrex also highlighted broader economic shifts that could sustain the new correlation regime. De-globalisation, demographic pressures, and the cost of decarbonisation all point to structurally higher inflation, which could erode the traditional bond-equity dynamic. In this environment, diversification beyond conventional asset classes becomes critical.
Kev Toohey, principal at Atchison, an asset consultant, echoes this sentiment, emphasizing the importance of identifying the key drivers of cross-currency valuations. “The forces shaping currency markets tend to follow identifiable trends, and the ability to pinpoint which factor is currently dominant is more critical than relying on any single valuation signal,” Toohey explains. “We have found success in employing systematic currency managers who can capitalize on these trends and extract alpha. These strategies, in aggregate, often exhibit low correlation with traditional growth assets, making them a valuable addition to diversified portfolios.”
“If you’re looking for a hedge, there are explicit and implicit options,” Harrex noted. “Explicit hedges like put options are difficult for private wealth investors to implement. That leaves implicit hedging. If bonds are no longer reliable, FX is an alternative that deserves more attention.”
To address this need, P/E Investments offers the P/E Global FX Alpha Fund through Macquarie Professional Series. This fund employs a systematic currency derivatives trading approach to generate returns with low long-term correlations to bonds and equities. It exhibits negative correlations to equities during market downturns and is considered a ‘liquid alternative’ due to its daily liquidity.
Harrex emphasizes the heterogeneity of liquid alternatives, noting that they will not all perform similarly. He believes that in a scenario where bonds and equities show positive correlation, liquid alternatives will likely prove more efficient than illiquid options.
The Global FX Alpha Fund capitalizes on opportunities in the US$7.5 trillion-a-day global foreign exchange market, which is both highly liquid and inefficient. Harrex highlights the manager’s edge in exploiting inefficiencies, particularly in non-profit-maximizing trades, which account for half of daily currency trading.
“Those trades have to accept the price that day, because they’re related to trade or cross-border transactions. That makes it a very inefficient market – which creates tremendous opportunities for us,” Harrex said.
The strategy serves multiple purposes in client portfolios, acting as a return smoother, a growth play, and a diversifier.
The message for advisers is clear: while no hedge works in all environments, FX has demonstrated resilience when other diversifiers have failed. As market conditions evolve, the role of FX in portfolio construction is likely to grow.
For advisers, the challenge is no longer just about finding return-generating assets. It’s about identifying protective strategies that don’t compromise long-term performance. If bonds are no longer the reliable hedge they once were, foreign exchange might be worth exploring as a diversifier and resilient source of protection.
