Developing a Currency Overlay Strategy for Global Equities

As a portfolio manager at an international investment firm, you are tasked with developing a currency overlay strategy to hedge against exchange rate fluctuations while seeking to enhance returns from your firm’s global equity investments. Recently, the firm has expanded its investments into emerging markets, which have demonstrated high volatility in currency valuations.

Discuss the key considerations for implementing a currency overlay strategy in this context. Your response should include, but not be limited to, the objectives of currency overlays, the methods of hedging employed, the impact of currency risk on portfolio performance, and how to measure the success of your strategy.

In addition, consider the potential drawbacks of currency overlays and suggest ways to mitigate these risks. Use relevant examples to illustrate your points.