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Currency risk in trust portfolios: when base currency is not the whole story

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Why currency exposure needs to be governed deliberately rather than left to the manager, and the framework that lets trustees do it

4 mins
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Risk & Compliance Monitor Connect
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Author
tom-wiseman

Tom Wiseman

CEO

Tom is the Chief Executive Officer of Enhance Group overseeing our multi-jurisdictional Monitor and Select solutions from our Jersey headquarters.

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Most investment policy statements specify a base currency for return measurement. Most trust portfolios are not run, distributed or held in a single currency. The gap between the two is currency risk, and for trustees of internationally settled structures, it is often the single largest source of return volatility, the most poorly evidenced of all the risk parameters, and the one most likely to surprise beneficiaries when an FX move turns a good investment quarter into a poor distribution. This article explains why currency risk needs to be governed deliberately, the three lenses through which trustees should view it, and how Monitor’s mandate compliance framework tests it every quarter.

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Why currency is a governance question, not a market question

Currency exposure inside a trust portfolio rarely arises from a deliberate investment view. It arises from where the underlying holdings happen to be denominated, which is often a by-product of the manager’s security selection rather than a considered allocation. A USD-priced portfolio with substantial European equity exposure carries material EUR risk. A GBP trust holding US technology equities carries USD risk. A multi-currency trust paying distributions across jurisdictions carries several currency risks at once, often without any of them being explicitly chosen by the trustee or the manager. Currency risk is therefore primarily a governance question: what currency exposure has the trustee consented to, and is the portfolio operating inside it? Where the IPS specifies a base currency without specifying currency exposure limits, the trustee has given the manager implicit permission to take any FX position the manager chooses. Few trustees, on reflection, intend to grant that permission.

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The three lenses of trustee currency governance

01 Exposure

Measure currency exposure across holdings

Currency exposure must be measured at look-through, not at fund-name. A fund priced in GBP can hold 80% of its assets in USD-denominated securities; a global equity fund priced in USD can be 60% exposed to non-USD currencies through its underlying holdings; an ADR is a USD-priced instrument backed by foreign-currency cash flows. Manager reports typically present allocation by reporting currency or fund domicile, neither of which tells the trustee what the portfolio is actually exposed to. Monitor calculates currency exposure on a look-through basis at the end of every quarterly cycle, presents it against the IPS allowable range, and reports it anyway where no range exists so the trustee can see what the manager has chosen to run.

02 Distribution

Match exposure to beneficiary distribution needs

Currency exposure should not be assessed against base currency alone. If the trust distributes 40% of its income to a beneficiary in EUR and 60% in GBP, the portfolio’s currency exposure should reflect that distribution profile, not the trustee’s base-currency reporting preference. The same principle applies to capital distributions: a trust planning a USD-denominated capital release in two years should carry USD exposure proportionate to that liability, not exposure drifted there by the manager’s asset selection. Distribution-aware currency governance is the trustee’s answer to FX risk, not currency hedging in isolation.

03 Hedging

Assess whether and how to neutralise the residual

Once exposure is measured and distribution needs are mapped, the residual currency risk, the gap between the two, becomes the hedging question. Hedging is not always the answer. Hedge instruments have costs, hedge ratios drift with market moves, and rolling hedges incur ongoing operational overhead. For a long-term balanced portfolio with diversified distribution needs, the residual may be acceptable unhedged. For a trust with concentrated short-term distribution needs, hedging may be the prudent answer. The trustee’s duty is to make the decision deliberately and document the reasoning (see Action Points), not to leave currency exposure to drift wherever the manager’s asset selection happens to take it.

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How Monitor tests currency risk quarterly

Every Monitor portfolio review reports look-through currency exposure at the portfolio level, the client level (consolidated across every portfolio the client holds) and the practice level. Where the IPS specifies currency exposure limits, mandate compliance checks test the portfolio against them; where the IPS is silent, the Governance Manager (see The Governance Manager) flags the gap and helps the trustee define appropriate limits. Where distribution profiles are documented, the review framework can test exposure against multiple currency tolerances, not just the base currency.

Currency action points are tracked in Connect through the same workflow as every other action point: raised, assigned, responded to, resolved. The audit trail satisfies the evidencing layer of the trustee’s duty without a separate workstream.

What good IPS currency clauses look like

Sensible IPS currency clauses include three elements: the base currency for reporting; the permitted currency exposure ranges, set at look-through with reference to the trust’s distribution profile rather than to the reporting envelope; and the hedging policy, specifying which exposures are hedged, by which mechanism and within what tolerance. An IPS that names a base currency but is silent on the other two has left the entire substantive currency decision to the manager by default. Monitor enforces what the IPS specifies and reports what the IPS omits, so trustees can see where the policy needs filling in.

IPS element Illustrative wording
Base currency Performance is measured in GBP.
Permitted GBP exposure Minimum 50%, target 65%.
Permitted non-GBP exposure Up to 50% combined, of which up to 30% USD, up to 20% EUR, up to 10% other developed-market currencies.
Distribution alignment Currency exposure to be reviewed against the trust’s documented distribution profile annually.
Hedging approach Hedging discretion delegated to the manager within IPS limits; rationale to be documented at each review.

The bottom line

Currency risk in trust portfolios is rarely chosen and rarely measured, yet it is often the single largest driver of return volatility for internationally settled structures. If you govern only against a base currency, you have left the currency decision with the manager by default. Enhance tests currency exposure at look-through every quarter (if the data provided by the manager is granular enough for such analysis), against IPS limits where they exist and against trustee-relevant thresholds where they do not. You retain the governance decision. Monitor provides the evidence the duty requires.

Simple to implement. Designed for clarity.

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