To Hedge or Not to Hedge: The Slings and Arrows of Currency Risk in Minimum-Volatility Investing

The Journal of Index Investing, Fall 2014, Volume 5 (2), pp. 21-33.

Posted: 7 Oct 2013 Last revised: 13 Sep 2014

Date Written: October 7, 2013

Abstract

We found that it is important to address currency risk to take full advantage of the benefits of minimum-volatility investing. In our backtest that extended back to 1979, we found that hedging currency risk would have led to a higher Sharpe ratio by decreasing risk while maintaining return at a similar level. In the absence of hedging, a minimum-volatility portfolio’s currency risk creates a home bias and other distortions. Separating equity selection from currency risk built a portfolio that is low risk from a local-currency perspective. This local-currency portfolio historically delivered higher risk-adjusted returns which we attribute to better stock selection. We found this result to be consistent for multiple investor domiciles including the United States, Great Britain, Germany, Japan, and Australia. As a bonus, the hedged portfolio’s return was also less correlated with the global equity market, making it a better portfolio diversifier. To our knowledge, despite extensive research published on low-volatility investing, currency-related issues have not yet been reported on.

Keywords: minimum volatility investing, global equities, currency risk, currency hedging

JEL Classification: G12, G15

Suggested Citation

De Boer, Sanne and Norman, James H., To Hedge or Not to Hedge: The Slings and Arrows of Currency Risk in Minimum-Volatility Investing (October 7, 2013). The Journal of Index Investing, Fall 2014, Volume 5 (2), pp. 21-33.. Available at SSRN: https://ssrn.com/abstract=2337198 or http://dx.doi.org/10.2139/ssrn.2337198

Sanne De Boer (Contact Author)

Invesco ( email )

1166 Avenue of the Americas
27th Floor
New York, NY 10036
United States

James H. Norman

QS Investors ( email )

880 Third Avenue
7th Floor
New York, NY 10022
United States

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