Currencies: To Hedge or not to hedge
Frontier believes that currency hedging is very important for asset classes such as Global Bonds and Global Real Estate. As an example, the Citigroup World Government Bond Index returned 5.1% (USD) in 2005 on a fully currency hedged basis. This return was effectively the inherent return of the asset class. The un-hedged version of this same index returned minus -7%. Clearly, a decision not to hedge currency exposure in this asset class created a huge difference in the return achieved by the investor. By currency hedging, the investor is aiming to capture the pure asset class return and any associate risk premium.
When to Hedge?
Frontier believes that the currency hedging decision is governed by the source of the cash flows driving the returns of the asset class. As an example, for Global Government bonds, the coupon payments made to bondholders are denominated in the local currency ie Japanese Government bonds pay coupons in Yen and therefore it is vital to hedge the currency risk. Another example is commercial real estate. Whether the investor holds the physical building in Australia or an Australian REIT, the source of the real estate revenues and profits is in Australian Dollars and therefore it is important to currency hedge.
The case for currency hedging a global equity portfolio is less clear. For example, many of the companies located in the USA derive a large part of their revenues from outside the USA and many also implement their own currency hedging programs within the treasury function. Therefore, some investors take the view that the currency impact will even out over time. While this may be true, Frontier has decided that currency hedging all three of the big global asset classes (Equities, Fixed Income and Real Estate) is the most consistent approach.
Currency Choice for Investors
While the Frontier funds are currency hedged, we offer three major currency share classes to our clients. Therefore, the client can choose a hedged share class in either USD, GBP Sterling or Euro. Some clients choose a blend of these currencies to further diversify their investments.