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Currency Hedging: Aiming for Efficiency

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barrons-articleThe following is an excerpt from HELEN GUO AND LAURA RYAN | October 17, 2016 | Barrons.com |

Our research suggests it may be more efficient to make hedging decisions at the portfolio level on a currency-by-currency basis, especially for non-U.S. dollar-based investors. Hedging decisions made at the asset level ignore the relationship between currency exposure in one asset and other parts of a portfolio; imposing uniform hedge ratios at the portfolio or asset level limits one’s ability to benefit from the diverse risk/return trade-offs offered by different currencies.

In fact, our research found Australian and Japanese investors may be able to reduce tail risks (as measured by conditional value at risk (CVaR)) in a standard 60/40 portfolio by up to 1.5 percentage points and 3.0 percentage points, respectively, without sacrificing returns, relative to having a uniform hedge ratio at the portfolio or asset level.

For U.S. investors, hedging may be simpler: Our research showed the potential for no loss in efficiency even with a uniform hedge ratio. However, much depends on the investor’s return assumptions, risk model and portfolio allocations. In general, we believe that portfolio-level currency-by-currency hedging will always be optimal.

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