Hedging Important For Bonds, Too
Meanwhile, the case for hedging may be even stronger for fixed income. Especially now, with yields historically low, "FX [currency] swings can swamp bond portfolio income," warned BlackRock.
Unhedged bond holdings may double annualized portfolio volatility, according to the authors.
Again, the report's recommendation is for U.S. investors to fully hedge any international developed-market government bond exposure, investment-grade credit exposure and high-yield exposure.
Investors may be taking heed. The Vanguard International Bond ETF (BNDX)―which is hedged against currency fluctuations―has seen inflows of $2 billion this year, making the $8.1 billion fund the second-largest international bond ETF on the market, as well as the second-largest currency-hedged ETF on the market.
No Need To Hedge EM Exposure
The one area that BlackRock doesn't see benefiting from currency hedging is emerging markets.
When it comes to emerging markets, "FX exposure and carry (the income from interest rate differentials) are key sources of total return for local-rate portfolios. And hedging is often either impractical or prohibitively expensive," the authors noted.
The usual rules of thumb for dealing with foreign-exchange risks and opportunities do not apply in emerging market investing, they concluded.
Contact Sumit Roy at [email protected]