Currency Overlay for Global Equity Portfolios: Cross-Hedging and Base Currency

Abstract

The effectiveness of a currency overlay hedge for a global equity portfolio can be significantly affected by changes in the base currency. Base currency changes have no significant effect on the hedged portfolio risk; however, they may substantially increase or decrease risk relative to the unhedged position. Australian (AUD) and Canadian (CAD) forwards provide effective cross-hedging, particularly in combination with one or two other currency hedges. Hedge effectiveness is significantly improved by allowing for natural hedges via a dynamic approach that captures structural change and permits under-hedging of currency exposures.