Dynamic currency hedging is a risk management strategy that aims to vary the amount of hedging in order to provide better results than a static hedging strategy.
Dynamic Hedging Benefits
- Improved cash flows versus a passive hedge
- Mitigation of performance drawdown from US dollar depreciation
- Addition of excess returns versus the benchmark
The benchmark for dynamic hedging programmes is expressed as a hedge ratio:
- If the benchmark is 0% or unhedged, the objective of dynamic hedging will be to add value by increasing the amount of hedging when the exposure currency is going down, with the aim of generating profits from hedging that partially offset losses in the underlying portfolio.
- If the benchmark is 100% or fully hedged, the objective of the dynamic hedging will be to add value by reducing the amount of hedging when the exposure currency is going up, with the aim of reducing the losses from hedging while the underlying portfolio experiences gains.
- If the benchmark is 50% or another partially hedged ratio, the objective of the dynamic hedging will be to add value by varying the hedge ratio in both directions.
Comparative impact of dynamic hedging
The table below summarises the salient points of each approach and the expected benefits of a Dynamic Currency Hedging strategy.
Whichever solution is being considered, given that there are both risk and return consequences from owning currency exposure in all circumstances, the analysis suggests that currency exposure should be managed and not left unattended.