Currency Hedging - discretionary accounts

CFA Level III Derivatives
#1

Another extremely confusing/misleading question by CFAI:

Ostermann believes that currency markets are efficient and hence that long-run gains cannot be achieved from active currency management, especially after netting out management and transaction costs. She uses this philosophy to guide hedging decisions for her discretionary accounts, unless instructed otherwise by the client.

Q. Based on Ostermann’s views regarding active currency management, the percentage of currency exposure in her discretionary accounts that is hedged is most likely:

  1. 0%.
  2. 50%.
  3. 100%.

Solution

A is correct. Guten believes that, due to efficient currency markets, there should not be any long-run gains for speculating (or active management) in currencies, especially after netting out management and transaction costs. Therefore, both currency hedging and actively trading currencies represent a cost to the portfolio with little prospect of consistently positive active returns. Given a long investment horizon and few immediate liquidity needs, Guten is most likely to choose to forgo currency hedging and its associated costs.

The PM doesn’t believe in active currency management and hence chooses to leave all FX exposures 100% unhedged - which in itself is an active position. How can this make sense? As someone that hedges currency on a day to day basis I fail to understand the premises of this explanation. Wondering if anyone has a better explanation before I pull all my hair out.

#2

This is a pretty stupid question.
Just think, would you pay for active management at a higher fee if you believed the markets were efficient? No because outperform shouldn’t be possible across the longer term. Same thought process here.
Also FX is a risk exposure rather than an active position e.g. 5% portfolio allocation, so the PM doesn’t believe it’s worthwhile paying to hedge that risk factor

#3

Makes sense, thanks!