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Currency risk & FX hedging

Bron: Gosse Alderda, Aegon Asset Management - 10 september 2020

urrency risk can have a major effect on the risk-return profile of foreign investments. The magnitude of this impact depends on the specific asset class, but also on the context in which the investment is held, the wider asset portfolio and investor liabilities. In this article, we look at the impact of currency hedging on the risk/return profile at an asset class and total portfolio level. In addition, we also investigate the potential added value from adopting a dynamic currency hedging policy.

Hedging costs
Figure 1 shows that the interest rate differential between the currencies is by far the largest contributor to currency hedging costs, while the cross currency basis spread is especially relevant during times of crisis (e.g., the 2008 financial crisis). However, the interest rate differential had very little explanatory power in predicting future exchange rates. As a result, currency risk can potentially earn an excess return.

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