When you invest in assets denominated in another currency — a global fund in US dollars, Swiss equities, or a Chinese corporate bond — you take on two risks: the risk inherent to the asset itself and the risk arising from movements between that currency and the euro. If the asset rises by 5% but the euro appreciates by another 5%, your return can be neutralised. To hedge currency risk, various strategies and financial tools can be used — financial instruments designed to neutralise, in whole or in part, exchange-rate movements. The most frequent are:

• Forward FX and futures contracts: These contracts allow you to lock in today an exchange rate for a specific future date, protecting the investor against exchange-rate moves. These contracts are the basis of many institutional hedges.
• Currency options: These are similar to forward contracts but with a key difference. In the former, the buyer has the right and the obligation to trade at the rate set in the contract. With currency options, the buyer has the right but not the obligation, and can choose to trade at the agreed exchange rate or at the spot rate at the time of sale if that is more favourable. The buyer of these contracts must pay an amount (“premium”) to obtain this right.
• “Hedged” share classes of funds or ETFs: These are investment vehicles in which the fund manager undertakes to mitigate or eliminate currency risk. Investors who buy these products will not bear FX risk in their investment.
• Other types of currency hedges exist that are more oriented to institutions and industry professionals, such as currency swaps.

Key Considerations

1. Lower volatility: By hedging currency risk, you remove one of the main risks in an investment, so expected volatility will be lower.
2. Cash-flow planning: Putting a currency hedge in place facilitates an exact forecast of future receipts or payments.
3. Cost: Implementing a hedge entails a cost for the buyer of the hedge. This may be charged as fees or price differentials. Additionally, in some cases — such as forward contracts or “hedged” classes of investment products — you may forgo gains if the exchange rate moves in your favour.
4. Maturity: Hedges usually have a predetermined maturity date; a decision will need to be made about renewing them when that date arrives.
5. They do not cover other risks: Hedging FX risk mitigates or eliminates that specific risk, but your investment will still be exposed to the risks inherent in any investment (credit, market, or interest-rate risk, etc.).

Generic Example

A European investor holding a portfolio of US equities denominated in dollars can hedge FX risk by buying a forward contract that allows them to sell dollars at a pre-agreed exchange rate on a future date, protecting themselves — fully or partially — from a possible depreciation of the dollar against the euro. In this way, the investor locks in the exchange rate that will apply to a future sale on a set date.

Who Is It Useful For?

For investors whose time horizon, reference currency, or risk tolerance makes it relevant to stabilise the currency component. There is no universal answer: the balance between cost and benefit depends on each client’s profile and the macroeconomic context.

At MoraBanc we offer currency-hedging solutions tailored to different profiles, always within the current regulatory framework and following an individualised analysis.

This article is for informational purposes only and does not constitute investment advice. To assess whether a hedging strategy suits your objectives, consult an authorised financial adviser.