Managers are now cutting their dollar exposure and increasing hedge ratios for US stock portfolios.
Overseas asset managers and pension funds are increasingly taking steps to protect against a weakening US dollar, since it can reduce their ability to diversify their US equity portfolios.
US stock funds had a built-in dollar exposure; investors based on other currencies were protected in the past when the dollar was strong, even if Wall Street performed poorly.
The situation changed when US President Donald Trump introduced broad global tariffs on April 2, pushing US indexes and its currency to decline sharply.
The US currency hit a three-year low against other currencies, which reduced its impact on portfolio performance. Investors who benefited from a natural hedge are now concerned.
Managers are now cutting their dollar exposure and increasing hedge ratios for US stock portfolios.
Van Luu, global head of solutions strategy for fixed income and foreign exchange at Russell Investments in London, stated that 10% of Russell’s pension fund clients in Europe and the United Kingdom have increased hedge ratios on their global stock portfolio.
One of the clients increased its ratio to 75% from 50%, aiming to protect US stocks from a weakening US currency.
So far this year, the value of the US currency has dropped 10%, including a 6.5% decline since Trump’s “Liberation Day” in April.
Meanwhile, the S&P 500, the US stock index benchmark, has rebounded 24% since the April slump and is up 5.3%, reaching record highs. Outside the US, the MSCI gauge of global stocks has risen 16% this year.
Peter Vassallo, FX portfolio manager at BNP Paribas Asset Management, said it is no longer enough to look only at the stock market recovery and assume nothing has changed.
BNP has been reducing dollar exposure in client portfolios, including from pension funds, sovereign wealth funds, and central banks. The company has sold US dollars in stock and fixed income portfolios.
Vassallo stated that BNP has been investing in euros, yen, and Australian dollars against the US currency, a big contrast from last year.
Chief Investment Officer Justin Onuekwusi stated that the company decided to maintain a strategic hedge that will help reduce overseas currency exposure in favour of the pound by 20%. He added that he now views the US currency as closer to its long-term fair value and slightly reduced dollar hedging across managed portfolios.
According to April data from the US Treasury Department, foreign investors had more than $30 trillion in US securities, $17 trillion in equities, and $12 trillion in long-term debt.
Marcus Fernandes, global head of currency management at Northern Trust, noted that the divergence in risk correlations is sharper than before.
Russel data indicated that a euro-hedged version of the MSCI USA index was flat through May, while the euro-unhedged version fell 8.3%, showing euro-based investors the benefits of hedging.
The dollar fell 13% against the euro due to inconsistent US trade policies and growth prospects.
Managers typically hedge currency exposure by selling dollars against their base currencies, such as the euro or pound, in the foreign exchange forwards market and by using derivatives like options.
When the US currency loses power, these hedge funds gain value, offsetting losses on dollar-denominated stock portfolios.
John Velis, Americas macro strategist at BNY Markets, stated that forward selling of the dollar is now at its highest level in four years.
It shows that investors are shy to maintain long dollar positions, even though the value of the US currency can rebound when US trade policies change or geopolitical tensions (including the Israel-Iran conflict).
Velis stated that it is certain that the US currency is volatile. It’s the policy and macroeconomic volatility that makes investors concerned about holding the dollar due to the fear that it will further decline.
