Currency hedging improves funds' risk-adjusted performance

Non-listed real estate funds that use currency hedging strategies have experienced a reduction in risk of between 25% and 36% compared with unhedged funds, according to new research commissioned by INREV and carried out by academics at Western Sydney University.

The Impact of Currency on the Performance of European Non-Listed Real Estate Funds 2017 analysed returns data between 2001 and 2015, providing a long time series. Data was gathered from the INREV Annual Index.

The analysis focuses on four sample portfolios (sterling invested in Europe ex-UK real estate; US dollars invested in European real estate; euros invested in UK real estate; US dollars invested in UK real estate).

The research also includes results from a survey of investors, revealing a clear picture of how currency hedging works in practice. A full 71% of the investors surveyed have a currency hedging strategy. Over half of these (52%) hedged US dollars. Forty percent hedged UK sterling, 28% Japanese Yen, 28% Australian dollars and 16% Euros. The research found that 32% of investors hedged against all foreign currencies.

Nearly a third of investors (28%) applied a hedging strategy to their entire real estate asset portfolio, while the same proportion also hedged asset by asset. The preferred hedging instrument was forwards, used by 57% of investors.

This research shows that the optimal hedging ratio is likely to be somewhere in the range of 50% to 100%. Forward-looking analysis also suggested that the optimal ratio was 81%. Setting the hedge ratio correctly will have more impact than any other single decision relating to currency.

According to Henri Vuong, INREV's director of research and market information: "It's abundantly clear from this study that investors adopt a highly sophisticated approach to currency hedging and see it as a major part of the risk management framework for managing their exposure to international real estate. It’s also clear that fund managers of non-listed real estate funds need to factor currency movements into their thinking – it could make the difference between retaining or losing clients."