In its Fourth Quarter 2010 outlook (available here), money manager Leith Wheeler weighed in on the contentious topic of whether investors should hedge their foreign currency exposure. Here are some highlights from the report:
– A 2007 survey of pension plans found that almost 80% of small and mid-sized pension plans were not hedging their currency exposure on foreign investments, even though they were large enough to do it cheaply.
– Among those pension plans that did hedge, a common approach was to hedge half the currency exposure.
– Since currency movements are in the often in the opposite direction of stock market movements, a currency hedged portfolio is more risky than unhedged positions in many instances. Check out this post for an explanation on why currency hedged portfolios under perform when stocks and currencies move in opposite directions.
– While currencies can make big moves in either direction, it is unlikely that these moves will be repeated. Therefore, the decision to hedge or not is relatively less important than determining the asset mix of the portfolio.
The report concludes:
It is true that currency hedging could work extremely well if one could time it properly so as to put the hedge on when our dollar is weak, and then take it off later. However, as Alan Greenspan put it, “forecasting exchange rates has a success rate no better than that of forecasting the outcome of a coin toss”. Our dollar looks a little overvalued on some economic measures but we also recognize that this can persist for an extended period of time. Until such time as the Canadian dollar looks severely undervalued, hedging away foreign currency exposure may do more harm than good.