Published by : Russell Investments
As volatility rises in currency markets, investors are re-thinking their currency hedging policies and are looking to improve the risk-returns profile of their international currency exposure. Passive currency hedging has been widely implemented to fully or partially neutralise currency exposures derived from international assets. In passive hedging, the Target Hedge Ratio remains static regardless of market conditions, such as currency valuations, economic developments and sentiment. While passive hedging reduces uncompensated currency risk from international equity investing, investors can also make currency a rewarded source of risk. We believe that allowing Target Hedge Ratios to vary according to factors that are rewarded in currency markets (such as Carry, Value and Trend) is a smarter way to manage currency risk and generate additional returns.
This paper presents Russell Investments's Informed Dynamic Currency Hedging model (IDCH) which looks for opportunities to raise expected returns and reduce cash flow drawdown from currency hedging within an investor's international portfolio. The model aims to improve on the effectiveness of a passive programme by changing from time to time the Target Hedge Ratio at the currency level such that exchange rate exposures are tilted towards rewarded factors. The approach leverages Russell Investments's long-standing research and experience in currency factors (Conscious Currency) to provide a more attractive currency hedging policy.
Russell Investments's Informed Dynamic Currency Hedging model adds significant value compared to a static 50% hedged policy. For a GBPbased investor, Dynamic Hedging raises returns by 130 basis points per year 1, reduces the worst 1-year cash drawdowns by 55% and improves the return-to-risk ratio by 23% relative to a 50% static policy. In our view, Russell Investments's Informed Dynamic Currency Hedging goes a long way to solving the conundrum of what, when and how much to hedge.
Published:10 July 2017
Business Area: Risk
Type: Portable Document Format (.pdf)
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