Active Currency Hedging
Problem set: Investors vary in their approach to currency hedging of their international growth asset portfolios, some choosing not to hedge, others choosing to passively or actively hedge. Considerations in decision-making include the implications on/for risk diversification, for example providing an element of downside protection during tail events without negatively impacting liquidity.
Objective: The objective of this case study is to determine whether Edge/Wise’s active AI-driven currency hedging strategy can achieve superior risk diversification when compared with traditional passive and active PPP (Purchasing Power Parity-based) currency hedging strategies. Hedging strategy comparisons are based on an AUD-denominated US Equities portfolio (S&P500).
Approach: The benchmark for comparison for the three scenarios is the S&P500 price index AUD Unhedged. The hedge instrument applied is AUDUSD. The hedge ratio applied in all three cases is 50% of the total investment.
Return correlations were compared between:
(i) the S&P500 benchmark portfolio vs the 50% passively hedged portfolio
(ii) the S&P500 benchmark portfolio vs the 50% active PPP-based portfolio,
(iii) the S&P500 benchmark portfolio vs the active Edge/Wise portfolio.
Observations and outcomes: We observed meaningful reductions in return correlation between the benchmark portfolio and the Edge/Wise actively hedged portfolio in all cases – ie for the periods leading up to the GFC and Covid tail events, as well as through the tail event periods themselves. The risk diversification objective in those periods were fulfilled, and appreciably improved over traditional passive and PPP-based hedging strategies.