(pictured: Ugo Lancioni)
Neuberger Berman is introducing a new concept in currency hedging which it calls the “Dynamic Ideal Hedge Ratio”. It integrates dynamic or active management within a total portfolio’s risk management, which tends to reduce individual manager risk and style risk.
In a paper written by three of its specialists the manager says currency hedging has not changed very much in years, with the main passive and active strategies each having drawbacks. The goal of their new strategy is to set a hedge ratio that is satisfactorily rewarding for the overall portfolio at any point in time.
One of the paper’s authors, Ugo Lancioni, the firm’s head of global currency, says: “When so much effort is expended to make asset allocation more dynamic it is odd that currency risk gets left out.” The Dynamic Ideal Hedge Ration takes currency hedging a step forward by making it forward-looking as well as fully integrated into the whole-portfolio allocation process, he says.
Until now, most investors have taken one of five traditional approaches to currency risks, Neuberger says. They are:
- Remaining unhedged
- Hedging 100 per cent of their exposure “passively”
- Part-hedging their exposure (50 per cent, for example)
- Employing a “static” strategic hedge ratio determined by the historical relationship between the underlying portfolio and its foreign currency exposures (a refined version of the part-hedged solution)
- Hedging statically with an additional “active” strategy to exploit pure alpha-generating opportunities
“We believe all five have substantial drawbacks,” the paper says. “Staying unhedged involves unrewarded risk. A full hedge can be expensive. A static strategic hedge ratio integrates foreign-currency risks into the whole-portfolio construction process but remains a set-and-forget approach based on historical correlations. An active hedge adds a dynamic element, but one that is unrelated to the broader portfolio construction process and which can create big exposures to manager risk and style risk. The carry strategy damaged many hedging programs during 2007-08, for example.
“We suggest combining the best of both worlds: ‘Dynamic’ in adapting to changing markets and ‘Ideal’ because it integrates currency risk management into whole-portfolio risk management.”