Currency hedging is one of those topics that sounds deceptively simple — you own foreign assets, the Aussie dollar moves against you, so you hedge it out. Done. Except it's absolutely not done, because the decision of how much to hedge, when to hedge, and what instrument to use reshapes your entire portfolio's risk profile in ways that aren't obvious until you're staring at an unexpected correlation spike at 2am.

The direct answer is this: Australian institutions typically use a currency overlay — a separate, actively managed layer sitting on top of the physical portfolio — to control foreign exchange exposure without disturbing the underlying asset allocation. The overlay manager hedges using forward contracts or currency options, and the hedge ratio (often 50–100% for fixed income, lower for equities) is calibrated to the institution's liability structure, return objectives, and crucially, how AUD correlates with the assets being hedged.

CONCEPTA currency overlay separates the FX decision from asset selection — giving institutions precise, independent control over both.
WARNINGFully hedging equities can inadvertently increase portfolio volatility — AUD often falls when global equities fall, providing a natural cushion.
KEY IDEAHedge ratio isn't a set-and-forget number — it should respond to the current correlation regime between AUD and your foreign asset classes.

Here's where it gets genuinely interesting. The AUD behaves like a risk-on currency — it rallies when global sentiment is bullish and sells off hard when panic hits. For an Australian institution holding global equities, an unhedged position means AUD depreciation partially offsets equity losses during drawdowns. That's a natural hedge. Strip it out with a 100% overlay and you've removed a covariance benefit you were getting for free.

Hedged vs Unhedged Volatility (Illustrative)0%5%10%15%Global EqGlobal FIBlendedUnhedgedFully Hedged

The covariance mechanics matter enormously here. When you hedge currency, you alter the correlation matrix of your whole portfolio. Global fixed income hedged back to AUD typically shows lower volatility — the currency noise is removed and the bond's duration characteristics dominate. Global equities are a different story. Numerous institutional studies and RBA research have shown that hedging global equities can actually lift total portfolio volatility for Australian investors, precisely because of that risk-on AUD dynamic. So the textbook answer of "hedge everything" can actively work against you. Smart overlay managers monitor rolling correlations and adjust hedge ratios dynamically rather than anchoring to a static number. For anyone wanting to build the conceptual foundation, the currency overlay explainer on Investopedia is a clean starting point, and the Wikipedia article on foreign exchange hedging covers the mechanics of forward contracts in useful depth. Understanding how covariance affects portfolio construction on Investopedia will help you see why changing one input — currency exposure — ripples through every risk number you produce.

The practical takeaway is straightforward: before setting your hedge ratio, model the correlation between AUD and each foreign asset class, not just the FX volatility in isolation. Your hedge ratio should be an output of that analysis, not an input.

Hedge with purpose, not habit — because in portfolio construction, the best risk to remove is the one that isn't already working in your favour.

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