State Street: European investors hedge more against FX risk than US peers

State Street: European investors hedge more against FX risk than US peers

20 november 2024

Valuta
Valuta dollar euro (Shutterstock)

Key findings:

  • Investors in the United States hedge less than investors in other domiciles
  • Equity investors hedge less than fixed-income investors
  • Investors tend to pick and stick to target hedge ratios
  • Average hedge ratios evolve over time, driven in part by currency, equity and bond factors
  • Even after accounting for other factors, investors hedge more post-Global Financial Crisis

Over the past weeks, the euro has fallen sharply against the dollar, bringing foreign exchange risk hedging back to the forefront of European institutional investors' agendas. In a recently published study, State Street investigates on how global portfolio investors hedge foreign exchange risk in their equity and fixed income portfolios over the past 25 years.

'Our findings imply that all is not symmetric in the world of FX demand. If US and European investors each buy equivalent amounts of foreign assets, the Europeans will tend to hedge more and thus, impact currency demand less. The same applies to equity versus bond allocations: Shifting from foreign bonds to foreign equities, which are less hedged, may create net positive demand for the foreign currency as forward hedges are unwound. Finally, since investors stick to hedge ratios, local return shocks in foreign markets create currency demand as investors seek to rebalance their hedge ratios,' Alex Cheema-Fox, Head of Investor Behavior Researcher at State Street  Associates, explains.

Alex Cheema-Fox and his team used proprietary custodial data to observe monthly historical stock, fixed income, and currency positions from a large group of institutional investors. They focussed on assets denominated in “G10” currencies (AUD, CAD, GBP, EUR, CHF, JPY, NOK, SEK, NZD and USD).

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