Currency Hedging in Global Equities: Lower Risk at Any Cost?

While the hedge effect developed relatively steadily, the unhedged currency effect at times ranged from around +14% to −28%. Over the long term, the return effects of the two approaches were relatively close, but their risk profiles differed considerably. What matters, then, is not just the cost of hedging, but also how the unhedged currency exposure contributes to the risk of the overall portfolio.
 

Currency Risk as Part of Overall Portfolio Risk

A full currency hedge naturally removes the fluctuations caused directly by exchange-rate movements. That does not automatically make the equity portfolio as a whole less volatile. Whether hedging reduces total risk depends on how equity and currency returns interact.

If the two are positively correlated, currency movements tend to amplify fluctuations in the equity portfolio, and hedging reduces risk. If the correlation is negative, currency exposure can provide a natural diversification benefit. For example, if the US dollar appreciates against the euro when equity markets fall, it can offset some of a euro investor’s losses. In that case, a full hedge would remove both currency risk and this diversification benefit.

Figure 2 shows how much this relationship changes over time. The rolling three-year correlation between returns on the MSCI World’s weighted currency basket from a euro perspective and local equity returns has changed sign several times since 2000. It averaged 0.19 between 2000 and 2007, compared with −0.32 between 2008 and 2014, and reached a low of −0.46 in May 2012. Since 2022, the average three-year correlation has again been negative. The diversification benefit of currency exposure thus depends on the market regime. One plausible explanation is that, during periods of stress such as 2008 or 2022, investors sought the dollar as a safe-haven currency, causing it to appreciate while global equities fell. In that scenario, unhedged currency exposure cushioned losses.

Figure 3 shows how these changing correlation regimes affect overall risk. Between 2000 and 2007, a full hedge reduced annualised volatility from around 16.2% to 13.9%. The hedged version was also considerably less volatile between 2015 and 2021. Between 2008 and 2014, however, the opposite was true: A full hedge increased volatility from around 17.3% to 18.1%. Since 2022, the two versions have been virtually level at 14.17% and 14.14%. In recent years, a full hedge has not reduced portfolio volatility.

The key consideration is therefore not the volatility of a currency in isolation, but how it behaves when the equity portfolio comes under pressure. When the correlation is negative, an unhedged currency exposure can reduce overall risk despite its own fluctuations.
 

The Risk-Minimising Hedge Ratio Moves With the Market

Because the relationship depends on the market regime, the hedge ratio that minimises risk cannot be a fixed number. Figure 4 illustrates this using blended portfolios that are reconstituted daily with a fixed mix of the hedged and unhedged indices. Across the full period, volatility is lowest at a hedge ratio of around 80%. The figure differs substantially between market regimes, however. From 2008 to 2014, the risk-minimising hedge ratio was just 22%. Since 2022, it has been approximately 51%. In both 2000–2007 and 2015–2021, the minimum within the range examined was reached with a full hedge.

Figure 4 also highlights an important practical point: In three of the four market regimes—all except 2000–2007—the ranges around the volatility minimum are relatively broad. Across the full period, hedge ratios between approximately 52% and 100% produced volatility no more than 0.10 percentage points above the minimum. Similarly broad ranges appear within individual regimes. Since 2022, for example, portfolios with hedge ratios between 23% and 80% have remained within 0.10 percentage points of minimum volatility. Positioning within a relatively broad low-risk range therefore appears more important than hitting the exact hedge ratio that proves optimal in hindsight.

The width of these ranges also changes the cost-benefit calculation. Beyond a certain point, the additional risk reduction from a higher hedge ratio diminishes considerably, while carry costs rise roughly in proportion to the hedged share. With hedge carry most recently at −1.4% a year as of June 2026, raising the hedge ratio from 50% to 100% would have cost around 0.7 percentage points of annual return, assuming unchanged interest-rate differentials. Over the period since 2022, volatility would not have fallen; it would have risen from 13.8% to 14.1%. Moreover, the risk-minimising hedge ratio is known only in hindsight, whereas carry costs can be estimated in advance. The broader the low-risk range, the smaller the penalty for deviating from the retrospective optimum.
 

For Investors: Consider Cost and Benefit Together

Two questions are central to a currency-hedging decision: How high is hedge carry given the interest-rate differential? And how does currency exposure affect the overall risk of the equity portfolio?

Neither question requires an exchange-rate forecast. The risk-minimising hedge ratio depends on the correlation between equity and currency returns and on their relative volatilities. An expectation about future exchange-rate movements may justify a different hedge ratio, but that is an active return position and should be distinguished from an assessment based solely on risk.

The current environment presents a relatively clear picture. At 1.4% a year, carry costs are well above their average over the past 26 years, while the correlation between equity and currency returns is slightly negative. A full hedge therefore entails high ongoing costs without materially reducing overall risk. Partial hedging, by contrast, can achieve much of the potential risk reduction at a substantially lower cost while retaining some of the diversification benefit.