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The answer is A. Why not fully hedged?
Because she’s assumed an efficient market where no one can generate alpha.
Yes, that states that active management is not appropriate. 0% and 50% hedge imply potential active management, which is not appropriate.
I would interpret it as 0% means no active management of currency- which fits the belief of efficient market in this case. > 0% of hedging would mean to actively manage the portfolio currency exposure (I.e. hedging).
0% hedge means no active management? I thought 0% hedge means fully active management while 100% hedge means fully hedged.
Active Management would be you are doing some form of hedging (over or under), ie. anything but 0%.
Simply put, she does not believe in hedging, hence the % that’s hedged is 0.
Review the beginning of Section 4 of Reading 21
There are a variety of approaches to currency management, ranging from trying to avoid all currency risk in a portfolio to actively seeking foreign exchange risk in order to manage it and enhance portfolio returns. There is no firm consensus—either among academics or practitioners—about the most effective way to manage currency risk. Some investment managers try to hedge all currency risk, some leave their portfolios unhedged, and others see currency risk as a potential source of incremental return to the portfolio and will actively trade foreign exchange. These widely varying management practices reflect a variety of factors including investment objectives, investment constraints, and beliefs about currency markets. Concerning beliefs, one camp of thought holds that in the long run currency effects cancel out to zero as exchange rates revert to historical means or their fundamental values. Moreover, an efficient currency market is a zero-sum game (currency “A” cannot appreciate against currency “B” without currency “B” depreciating against currency “A”), so there should not be any long-run gains overall to speculating in currencies, especially after netting out management and transaction costs. Therefore, both currency hedging and actively trading currencies represent a cost to a portfolio with little prospect of consistently positive active returns. At the other extreme, another camp of thought notes that currency movements can have a dramatic impact on short-run returns and return volatility and holds that there are pricing inefficiencies in currency markets. They note that much of the flow in currency markets is related to international trade or capital flows in which FX trading is being done on a need-to-do basis and these currency trades are just a spinoff of the other transactions. Moreover, some market participants are either not in the market on a purely profit-oriented basis (e.g., central banks, government agencies) or are believed to be “uninformed traders” (primarily retail accounts). Conversely, speculative capital seeking to arbitrage inefficiencies is finite. In short, marketplace diversity is believed to present the potential for “harvesting alpha” through active currency trading. This ongoing debate does not make foreign-currency risk in portfolios go away; it still needs to managed, or at least, recognized. Ultimately, each portfolio manager or investment oversight committee will have to reach their own decisions about how to manage risk and whether to seek return enhancement through actively trading currency exposures.
I understand the dilemma
Active management means taking on risks or removing them - with respect to investor’s own views.
Hedging means removing the risk. So 25% hedge means removing 25% risk from the portfolio as the views match that of the market.
If markets are completely efficient, then the investor would no “deviate” from market risks for her horizon=long-term.
Hence “no” hedging