|
"For Swiss investors seeking to maintain international diversification while improving the efficiency of currency risk management, we believe dynamic hedging presents a differentiated alternative to traditional static hedge programmes." |
 |
Currency hedging has become a critical part of portfolio construction for Swiss investors. Yet the investment environment has changed. A strong Swiss franc, elevated hedging costs and growing liquidity pressures have exposed some of the limitations of traditional static currency hedging programmes. This paper explores whether a more flexible approach to currency risk management can help investors improve portfolio efficiency while maintaining the benefits of global diversification.
The Swiss franc's long-standing safe-haven status has encouraged many investors to hedge overseas assets back into their domestic currency. However, fully hedged portfolios face two challenges. First, higher interest-rate differentials have increased the cost of maintaining currency hedges. Second, investors risk missing potential gains if the Swiss franc weakens from historically elevated levels. As a result, we believe it’s time to reconsider whether a fixed hedge ratio remains the most effective approach.
What is dynamic currency hedging?
Dynamic currency hedging differs from traditional hedging by adjusting hedge ratios over time rather than maintaining a constant level of protection. When the Swiss franc is expected to strengthen, hedge levels can be increased. When the franc is expected to weaken, hedge exposure can be reduced. The objective is to manage currency risk more efficiently while reducing unnecessary hedging costs and improving long-term outcomes.
Why static hedging may create hidden risks
Many investors view currency hedging primarily as a tool for reducing exchange-rate volatility. However, static hedging can also create liquidity risks. Currency hedge programmes typically use derivatives that can generate collateral calls and cash outflows during adverse currency moves. In periods of market stress, these cash demands can arrive at the same time as falling asset prices, potentially forcing investors to sell assets when valuations are most attractive.
Dynamic hedging seeks to address this challenge by actively managing hedge exposure and potentially reducing the size and frequency of collateral demands. Historical simulations presented in this paper suggest that a dynamic approach could have reduced cashflow volatility and lowered collateral pressures compared with a traditional fully hedged strategy.
Can dynamic hedging improve portfolio resilience?
The paper examines how dynamic currency management may enhance portfolio outcomes in several ways:
- Potentially reducing collateral calls and liquidity pressures.
- Seeking to capture opportunities created by large currency market moves.
- Potentially improving long-term returns relative to fully hedged approaches.
- Providing diversification benefits during periods of significant equity market stress.
- Historical analysis suggests that the benefits of dynamic hedging have been most pronounced during periods of severe market weakness, highlighting its potential role as a source of portfolio resilience when diversification is needed most.
A systematic approach to currency risk management
The paper also outlines Insight's systematic framework for dynamic currency hedging, which is powered by its Alt Risk Premia (Alt-FX) strategy. The approach combines multiple proven currency factors, including momentum, volatility, value, carry and quality, with the aim of adapting to changing market environments and capturing a diverse range of currency risk premia.
