U.S. investors who hedge against a rising dollar when buying shares overseas may end up with more risk rather than less, according to Catherine LeGraw, a member of Grantham, Mayo, Van Otterloo & Co.’s asset-allocation team.
“There is little notable risk reduction beyond a one-year holding period,” McGraw wrote two days ago in a report. “For longer investment horizons, hedging has resulted in marginally higher volatility.”
The attached chart shows this by comparing the performance of the MSCI World Ex-U.S. Index in local currencies and dollars since March 2005. The local index’s volatility for the 10 years ended in March was 14.6 percent, about four percentage points less than the dollar version, according to data compiled by Bloomberg. Both consist of stocks in 22 developed markets.
Futures, options and other types of currency hedges have become less effective over time because companies have become more global, McGraw wrote. The Boston-based analyst cited data showing companies in the MSCI EAFE Index, a gauge of developed markets in Europe and Asia, generate less than 35 percent of sales domestically. The figure fell from 60 percent in 1992.
Even if the hedging is effective, investors may find that their stock holdings are just as volatile as they were before, she wrote. That’s the case because international shares would track U.S. equities more closely and currency contracts might magnify risks stemming from unusual events, the report said.
“As a rule, we do not hedge currency for equity investments, but there are exceptions,” McGraw wrote. For instance, if GMO owns the shares of several companies having most of their costs and revenue in a local currency, the firm might offset the foreign-exchange risk, she wrote.