Currency hedging: When one size doesn’t fit all
What do a US-based retailer ordering goods from a supplier in China to be paid in 90 days in Chinese yuan; a Swiss investor buying an S&P 500 tracker; and a British retiree living in Australia receiving a pension in pounds sterling have in common?
All three are exposed to the foreign exchange markets, where close to USD 10 tn is traded each day. These vast flows produce currency swings that can hurt profits erode investments, and dent cross-border transfers.
Rather than treating currency hedging as a binary decision, we argue it should be viewed through the lens of risk-adjusted returns and integrated into the broader investment and portfolio construction process.
For many investors, currency fluctuations have long been seen as a risk to be eliminated, often resulting in an all-or-nothing approach to hedging. Investors typically either fully hedge their portfolios or leave them entirely unhedged. Our research challenges this conventional wisdom. The currency risk can be mitigated with hedging—a way of reducing or removing the risk of being caught on the wrong side of a foreign exchange swing.
In our study, we examine a range of currency hedging strategies from the perspective of investors with different reference currencies, investing across different asset classes globally. The evidence shows that the ideal hedge ratio can shift significantly over time, depending on the currency pair and asset class in question.
We assess four hedging strategies: two dynamic and two static. Dynamic strategies actively adjust the hedge ratio in response to market conditions. Static strategies, by contrast, maintain a fixed hedge ratio over time.
Our findings highlight the importance of a nuanced, flexible approach to currency hedging—one that recognises the diversity of investor needs, asset classes, and market environments. As we show, in the currency markets, one size doesn’t fit all.
