Identifying The Risks
The table below summarizes a quick calculation of return/risk, and highlights the differences between hedged and unhedged portfolios. In every case, the return/risk ratio of the hedged portfolio is higher. So over the long run, it seems that dollar-based investors that hedge will have more efficient portfolios. But the long run here is a long time. Do we reach a different conclusion if we shorten the time frame?
|Full Period (12/31/94 - 4/30/15)|
|Return/Risk Ratio||Hedged||Unhedged||Efficiency Difference
The table below shows the return differentials of hedged and unhedged investors over two time frames. First, we look at a 7-1/2-year period of a strengthening euro, and then a 6-1/2-year period of a declining euro.
|Increasing Euro (11/30/00-6/30/08)||Decreasing Euro (6/30/08-4/30/15)|
|Annualized Returns||Hedged||Unhedged||% Difference
We have purposefully picked time frames very close to the trough and peak of the euro, as to better understand what the worst-case scenario is for someone who gets their timing wrong.
As we can see, if you get the currency direction wrong, it can have significant effect on the returns. A Europe investor who is hedged, while the euro is going from essentially 0.9 to 1.60, loses almost all of their return (0.30 percent versus 7.17 percent). On the other hand, a European investor who is hedged while the euro goes from 1.6 to 1.1, adds 3.94 percent per year in returns.