Deutsche advises FX-hedging on stock portfolios

Hedging foreign-exchange exposure is currently cheap, says Christian Nolting of Deutsche Private Wealth Management, who gives his views on various currencies.

The current low-interest rate environment in most countries means hedging those currencies' exposure is relatively cheap, says Christian Nolting, head of portfolio management and lead strategist at Deutsche Private Wealth Management in Singapore. As a result, the firm is trying to hedge where it can, to the extent of advising clients to be fully FX-hedged on their equity portfolios.

But it works on a case-by-case basis. "You have to take into account the type of performance you expect, look at the currency itself and whether it makes sense to hedge," says Nolting. "For example, you may not hedge if it's too expensive to do so, and you may even need to rethink the investment if it doesn't make sense to hedge because of the cost."

"To this end, the first step is to think not only about the security itself, but also about the currency development, and that maybe hedging could be a possibility if you are expecting a negative performance impact from the currency side," he adds. "However, this only makes sense if there is enough performance potential left after hedging."

It's always crucial to stress to clients that investing in foreign securities also means investing in the related currency, adds Nolting. They then have to decide whether they want the foreign exchange exposure. "If you think the currency makes sense, you should leave the portfolio position unhedged, if you have a clear view that a positive performance could result from the currency exposure," he says.

Certainly, some have noted a growing trend towards managing FX risks in some quarters of the asset management industry. AsianInvestor reported in September that declining returns on investment in illiquid strategies such as private equity, real estate and infrastructure have heightened the impact of currency movements on the performance of these asset classes. That situation has led to some such investors paying to hedge FX exposures for the first time.

As for the outlook on currencies for 2010, Nolting suggests the dollar is worth looking at. It is likely to depreciate against emerging-market currencies this year, but stabilise against the euro and strengthen against the yen. One reason for this is that US growth for 2010 is forecast to be better than previously expected (3.5%, according to Deutsche Bank), as against 1.5% in the euro area and 1% in Japan.

Another factor to positively affect dollar strength will be the carry trade, with investors turning back to the yen as a funding currency, notes Nolting.

Another issue that many analysts have raised is the debate about Greece potentially defaulting and its likely negative impact on the euro. That situation, too, means the dollar may not be such a bad environment to be in in 2010.

The euro, on the other hand, is looking rather less attractive, with fears emerging that it may not be as stable as in the past, he says. One reason for this, analysts say, is that countries such as Greece, Ireland, Italy, Portugal and Spain are in an unfavourable situation.

Elsewhere, the renminbi is likely to appreciate over time. Clearly China is not very keen on letting that happen, Nolting says, but it wants to play a prominent role in G20, which it will have to pay a little price for that.

Another currency to look at may be the Brazilian real, which has some room for upside because of commodity prices, given that Brazil is a commodity-rich country. The real also has a "nice cushion" because of high interest rates, which Deutsche PWM expects will increase by 50 basis points in the first half of 2010. Currently the central bank's Selic (overnight lending rate) target is 8.75%.

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