Four Reasons Why We Do Not Hedge Against Currency Volatility
June 9, 2015
by Clas Olsson
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Currency volatility has continued to be a clear theme so far in 2015. As the US Federal Reserve has ended its asset purchases, the European Central Bank has launched aggressive monetary stimulus and quantitative easing (QE), and the Bank of Japan has continued its aggressive monetary policy. The result: Further strengthening of the US dollar, a significant weakening of the euro, and a relatively flat yen.
The volatility hasn’t been limited to developed markets. In emerging markets, the Russian ruble is down 40% and the Brazilian real is down 29% over the past year.1
Given this volatility, I’m often asked how our International Growth strategy manages these movements. The answer hasn’t changed over the 23-year history of the strategy: We don’t hedge for currency exposure, and we never have.
Stock selection trumps currency volatility in the long term
There are four main reasons we don’t hedge currency exposure in our portfolios:
- Our view is that while foreign currency exposure introduces some volatility in the short term, it does not have a significant impact on long-term volatility.
- We also believe that one of the key benefits that international funds can provide to US-based investors is to lower the correlation to the US market — and if you hedge the currency exposure, you instead increase the correlation and, therefore, also lower the diversification benefit.
- Hedging currency could also be largely redundant as many foreign companies have global operations with exposure to many different currencies, and they often hedge their own currency exposure directly. Due to this, simply hedging the home-country currency exposure of a company — just because of where it is domiciled — may not be effective; rather it might actually add additional risks.
- Hedging is costly and, as discussed above, can introduce unwanted leverage to a portfolio.
What matters most to the performance of our funds over time is stock selection. Regardless of the macroeconomic environment or currency movements, we remain focused on identifying attractive companies that fit our earnings/quality/valuation (EQV) investment process. This requires us to ask three main questions when analyzing a stock:
- Is its earnings growth sustainable?
- Is the company generating attractive returns and financially strong?
- Is the stock attractively valued?
In essence, we are much more concerned with what company managements are doing than central bankers. We believe this focus is key to delivering long-term growth potential to our investors.
Learn more about Invesco International Growth Fund.
1 Source: Bloomberg L.P., as of March 31, 2015
Senior Portfolio Manager
CIO of Invesco’s International Growth Investment Management Unit
Clas Olsson is chief investment officer (CIO) of Invesco’s International Growth Investment Management Unit and a senior portfolio manager with the Invesco International Growth team. Mr. Olsson is a lead portfolio manager on the Invesco International Growth strategy and the Invesco European Growth strategy.
Mr. Olsson began his investment management career in 1994 as an investment officer and portfolio analyst specializing in international equities with Invesco. He was promoted to portfolio manager in 1997 and assumed his current role as senior portfolio manager in 1999 and CIO in 2009. Prior to joining Invesco, Mr. Olsson was a communications officer in the Royal Swedish Navy.
A native of Vasteras, Sweden, Mr. Olsson became a commissioned naval officer at the Royal Swedish Naval Academy in 1988 and earned a BBA degree in 1994 from The University of Texas at Austin.
Read more articles by Clas Olsson on Invesco Blog.
Volatility measures the amount of fluctuation in the price of a security or portfolio.
Correlation is the degree to which to investments move in relation to each other.
Diversification does not guarantee a profit or eliminate the risk of loss.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.
Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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