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Currency Hedging: Adapting to Volatility

In the past, institutional investors largely ignored currency hedging in their international equity portfolios. With the globalization of the equity portfolio and recent market volatility, they no longer can afford to do so. However, how to hedge foreign-exchange exposure is receiving renewed scrutiny. Static hedges have delivered higher risk-adjusted returns compared with unhedged portfolios over a long-term horizon. The static hedge, however, faces challenges in adapting to changing market regimes. A dynamic approach that uses systematic signals such as Value, Momentum, Carry and Volatility delivered better risk-adjusted returns than traditional static hedge methods in our sample period, offering a new approach for volatile markets.

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