Based on this, it seems the FTSE would be the best candidate for hedging.
However, the reality seems to be different. In 2008, as the dollar played a safe haven role, both the pound and the FTSE fell together while after the Brexit vote, that correlation was completely inverted.
It is interesting to note that due to these correlations, in a multi-asset portfolio, mixed hedged and unhedged assets improve the risk-reward ratio. A portfolio with a 50 per cent allocation to global fixed income and 50 per cent in global equities hedged to sterling would have provided annualised returns of 7 per cent with 6 per cent volatility. Unhedged this becomes 8.2 and 7.5 per cent and mixed-hedged results in 7.8 and 6 per cent.
The fully hedged portfolio has a better risk-reward ratio; however, hedged fixed income and unhedged equities can have an important impact on absolute return numbers.
As currencies serve as an accounting tool, this introduces a bias in portfolio structuring and allocation. By removing any currency impact on portfolio returns it means that a portfolio will have to be structured either as a fully domestic portfolio or a geographically diversified portfolio, hedged back into the reference currency. In both cases, impact on absolute returns can be significant.
Signia Wealth investment team
