Does Currency Hedging Reduce Volatility?

By Charlie Bilello

“Currency adds volatility – and that can be costly.” – Sales Pitch

One of the main selling points for hedging currency exposure in foreign equities is a reduction in volatility.

The argument typically goes as follows: as a U.S. investor, why take on additional currency volatility if you don’t have to? Simply hedge the foreign currency exposure, leaving you with just the equities, a lower volatility exposure.

On the face of it, this seems to make perfect sense. Currencies have volatility, and so adding them to the risk equation would appear to make an investment more volatile (equity volatility + currency volatility = more volatility). But is this actually the case? Let’s take a look…

The oldest and largest currency hedged ETF is the WisdomTree Japan Hedge Equity ETF (DXJ), with assets under management of over $5 billion. Since its inception in June 2006, DXJ has an annualized volatility of 22.9% versus 21.6% for EWJ (the unhedged iShares MSCI Japan ETF).

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