What is "currency overlay"

n. The separation of currency risk outsourcing costs from asset allocation and security selection costs.

Currency overlay is a financial trading strategy or method conducted by specialist firms who manage the currency exposures of large clients, typically institutions such as pension funds, endowments and corporate entities. Typically the institution will have a pre-existing exposure to foreign currencies, and will be seeking to:

• limit the risk from adverse movements in exchange-rates, i.e. hedge; and
• attempt to profit from tactical foreign-exchange views, i.e. speculate.

The currency overlay manager will conduct foreign-exchange hedging on their behalf, selectively placing and removing hedges to achieve the objectives of the client.

Many types of currency overlay accounts are more focused on the speculative aspect, i.e. profiting from currency movements. These so-called 'pure alpha mandates' are set up to allow the manager as much scope as possible to take speculative positions. As such, they are similar in nature to foreign-exchange hedge funds in terms of objective and trading style. Currency overlay is a relatively new area of finance; the first institutional overlay mandate was awarded only in 1983 when the UK water Authorities Superannuation Fund awarded a contract to Record Currency Management.