Currency Hedging Magnifies Risks for Equity Investors, GMO Says

U.S. investors in global stock markets should think again about foreign-exchange hedging, which may increase their risks, according to GMO, an investment manager that oversees $116 billion.

“We are concerned that the term ‘currency hedging’ gives investors a false sense of security, as adding currency positions to equity investments may add risk,” Catherine LeGraw, a member of GMO’s asset-allocation team in Boston, said in a report. “While currency hedging may reduce volatility over short investment horizons for U.S. dollar investors, it does not reduce volatility over long horizons.”

Betting on currency moves may actually magnify risks, she said, citing the Swiss National Bank’s decision to abandon its currency cap to the euro on Jan. 15. Swiss equities fell almost 15 percent in local currency over the two days after the SNB move, while an unhedged U.S. dollar portfolio would have gained about 2 percent in the same period.

Hedging against foreign currency moves is also becoming less effective for equity investors because multinational companies have become more global and less linked to specific currencies, she said.

“Hedging increases tail risk by layering currency exposure to the equity investment,” LeGraw said. “Currency hedging equities increases the notional exposure, and therefore the magnitude of possible return or loss.”

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