Smart Currency Hedging for Smart Beta Global Equities
The Journal of Investing, Winter 2016
Posted: 12 Nov 2014 Last revised: 22 Oct 2016
Date Written: May 31, 2015
We investigate whether structurally hedging the currency risk of global equity products benefits long-term investors. Based on a 35 year back-test of 3 smart beta strategies from 6 currency perspectives, our answer is a qualified “yes”. Currency hedging was effective in reducing risk and generally improved medium to long-term Sharpe ratios, albeit at a small cost to average returns. It may not be the proverbial free lunch, but does appear a value meal from the risk-adjusted perspective that is most relevant in an asset allocation context. The most effective hedging strategy and the resultant benefits vary by investor domicile, the nature of the equity holdings, and over time. The benefits were strongest for defensive (low-volatility, non-cyclical) equity portfolios for investors from safe-haven currency zones, and least pronounced for cyclical equities held by investors using pro-cyclical currencies. Particularly since the Global Financial Crisis, being smart about how much of a portfolio’s currency exposures to hedge has been the key to avoiding perverse impacts.
Keywords: smart beta, alternative beta, currency hedging, currency risk, exchange rate risk, FX, global equities, low volatility, minimum volatility
JEL Classification: G12, G15, F31
Suggested Citation: Suggested Citation