LONDON/TOKYO/NEW YORK (Reuters) – Some European and Japanese bond investors are taking on more currency risk by buying dollar debt without protecting themselves against potentially devastating exchange rate swings as they seek ways to compensate for sub-zero yields at home.
A fund manager in Germany can buy 10-year U.S. Treasuries that offer minimal credit risk at yields of up to 1.6%, more than 2 percentage points more than for German Bunds.
But that juicier yield is available only if she eschews expensive currency hedging that could wipe out that whole premium — a vulnerable position that funds have traditionally avoided for fear of adverse exchange rate swings.
Hedging dollar exposure is expensive — at current prices, the German investor’s 2.2% yield pick up on 10-year Treasuries would become a 0.3% loss after hedging.
With some 40% of non-U.S. debt — about $15 trillion — now yielding less than zero, however, it’s a risk that funds —especially those with obligations to insurance policyholders and pensioners — seem prepared to take.
“For fixed income investors, the normal habit is to hedge currency risk, but this year we’ve seen a tendency to hedge less,” said Claire Dissaux, head of global strategy at fund Millennium Global, which helps clients manage FX exposures.
“If you are a euro zone investor, it’s expensive to hedge (dollar exposure) so there has been a temptation to not hedge. And if you didn’t hedge you will have done well.”
(GRAPHIC: Sovereign bond yield heatmap – here)
Hedges are usually implemented via currency forwards that specify the rate at which a currency may be exchanged over the contract period — usually three or six months. That effectively shields the fund if the foreign currency depreciates against its base currency.