April 2015
Currency hedging of investment assets in a Danish perspective.
By Christian Betz, Jyske Capital
This article reviews the effect of currency hedging for a Danish investor applying quantitative methods. The purpose of the article is to illustrate how currency hedging affects equities, bonds and mixed portfolios in foreign currency when the objective of such hedging is to minimise the variance of the return in DKK. The article may be read in continuation of the literary summary on currency hedging in a portfolio context (“Currency risk hedging of portfolios”, Jyske Capital, February 2015).
Background
Systematic hedging of assets in foreign currency and the degree of such hedging is gaining increasing attention in portfolio management. If the implicit currency risk in connection with the acquisition of assets in foreign currency is deemed to be non-compensated for, hedging should be performed, but is it worth the ‘trouble’ after hedging costs? Does the currency risk for foreign assets tend to be evened out over time and when involving more assets?
This article focuses on currency hedging with the objective of minimising the return variance in Danish kroner by calculating the optimal hedge ratio. Applying this ratio as the permanent hedge ratio, currency hedging of foreign equities and bonds is reviewed on an individual basis from a Danish investor’s point of view, including the effect on the return variance and development. Furthermore, portfolios of foreign equities and bonds are assessed on an isolated basis. Finally, the hedge effect on mixed portfolios is assessed in terms of return and return variance, including the effect on the portfolio diversification as a result of a permanent hedging rule.