Assets held overseas or denominated in a foreign currency can expose your investment portfolio and assets to currency risk. Here we will discuss the risks associated with holding stocks, bonds, real assets and cash denominated in a foreign currency, and options for mitigating this risk via hedging. Overall we believe that hedging as an investment strategy is an expense which will have the net effect of reducing the return of the portfolio over time.
Currency risk of stocks and bonds
The effect which exchange rate risk has on overseas assets such as stocks and bonds is a very complex subject. The performance of the foreign business issuing the securities is effected by currency risk due to its inventory, receivables, and other assets being denominated in the country’s currency. When stocks or bonds are issued and denominated in a foreign currency, they typically pay interest or dividends in that currency. The investor is therefore exposed to currency risk in a variety of ways.
A portion of these currency risks can be hedged using currency futures, however keep in mind that there are inherent costs associated with hedging. Additionally, there may be an underlying need to own assets denominated in the currency of another country, as discussed more below.
Currency risk of real assets
There may be an underlying need to hold assets in a foreign country, and real assets held overseas, such as real estate and commodities, can serve as both a currency hedge and an inflation hedge. An instance of this is where real property is held in a country to which the holder of the asset intends to return to at a future date, for example to retire.