GLOBAL – Investors don’t need not hedge currency over the long term because it “all comes out in the wash”, according to a new study by ABN Amro and the London Business School.
Researchers Elroy Dimson, Paul Marsh and Mike Staunton say: “It’s only worth having hedging if you’re not paying a lot for it.”
“Investing internationally expands the opportunity set and provides risk reduction through diversification across countries, asset classes, and currencies,” says the report – ‘the Global Investment Returns Yearbook 2005’.
“Currency risk does not add greatly to he long-run risks of international equity investment.
“Investors with no special insights about the prospects for different world markets should therefore hold as diversified portfolio as possible.”
“For longer term investors, however, foreign exchange hedging mitigates downside risk by no more than a small margin.
“Stock market risk is reduced more effectively by international diversification than by currency hedging.”
“It is the equities from weak-currency countries that have tended to outperform – though with considerable volatility.”
“Nowadays, hedging is easier, but sadly the benefits are smaller too. They are modest compared to the reduction in portfolio volatility from diversifying internationally.”
Used a database to examine the benefits hedging currency exposure over the last 106 years – although the data largely predates the swap market era.
The researchers have also found that currency performance does not predict equity market returns. “There’s very little in it over the broad sweep of history,” says LBS professor Elroy Dimson.
The study also looks at the current low bond yield environment, saying the situation is not that rare in historical terms.
“Thus while current UK real bond yields look very low by comparison with the past quarter-century, it is important to recall that there have been long periods of history during which the average real interest rate has been quite low.”