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Currency hedging 'barely matters' for long-term investors – LBS study

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  • Currency hedging 'barely matters' for long-term investors – LBS study

GLOBAL - Currency hedging should not be an approach pursued by all long-term investors and is a "zero-sum game", according to new research by Credit Suisse and the London Business School (LBS).

Speaking as the Swiss company published its Global Investment Returns Yearbook 2012, the authors of two of the three papers argued that hedging was an approach investors should carefully consider before implementing.

Paul Marsh, emeritus professor of finance at LBS, presented results that found investors from a cross-section of 19 countries - including the US, Canada, Australia and Japan, as well as Germany, Switzerland and Norway - would be left with the same average annualised returns over a 40-year period from 1972 whether they had hedged currency risk or not.

He singled out the US as an exception, noting that both stock market and fixed income investments saw stronger returns - 6.1% versus 4.7% on equities, and 4.6% versus 3.1% on bonds - when the domestic investor decided against hedging between 1972 and now.

"On average, over these other 18 currencies, the dollar was weak in terms of a real exchange rate," Marsh said. "You would have been better, with hindsight, not hedging. So, hedging hurt a US-based investor over this particular period."

He added: "Over the very long run, currency barely matters. The trouble with that is that not many investors have 112-year horizons, they need to be extremely patient for that."

Marsh argued that hedging actually introduced risk to the investment universe, noting that taking a short position on foreign interest rates and a long one on domestic rates left the long-term risk of a bet on local rates, compared with foreign ones.

"By leaving things unhedged, you can actually hedge against what you worry about most - which is unexpected inflation in your own country and currency," he said.

"The idea is, for longer-term, patient investors on a longish horizon, hedging should probably be the exception, not the norm."
 
However, fellow author and LBS professor Elroy Dimson challenged the accusation that their research revealed currency hedging was "useless", explaining that, for a long-term equity investor, it should instead possess a "limited" role.

He said there were many reasons to implement hedging strategies, such as pursuing a strategy that was not simply "buy and hold".

"What we're saying is that, as a long-term strategy, that will deny the equity investor the opportunity to diversify the risks of currency debasement in the home currency," Dimson said.

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