Plus Sole 24 Ore - 28/05/2022

STRATEGIES
Neutralizing the exchange rate makes more sense for bonds, where having the coupon matters
Marzia Redaelli

Speculating on exchange rate risk requires a high risk appetite. Conversely, hedging against currency fluctuations has costs, which make sense to bear if the investment goal is not speculation, but rather the opportunity offered by financial assets for reasons related to the fundamentals of the securities and the economic context of the area to which they refer.

For example, in the case of bonds, the aim may be to have an attractive coupon, without necessarily betting on the exchange rate. For stocks, however, the correlation between price and currency is more complex, because the return on investment also depends on the type of activity of the listed company, which may be favored or not by the strengthening or weakening of a currency, depending on where it generates its revenue.

Marco Galli, independent financial advisor, explains that he suggests clients diversify part of their portfolio into bonds from currency areas other than the euro, mainly in dollars. The exchange rate hedge, perhaps through an ETF that neutralizes currency fluctuations, and the relative amount depend on the investor's risk profile. "I direct part of the portfolios to US bonds," explains Galli, "with maturities up to a maximum of seven years, to take advantage of the yield differential. For bonds, it makes sense to hedge the exchange rate, especially if the goal is to have a certain coupon flow, which does not vary depending on currency movements. In any case, the risk must be weighed within the overall portfolio risk."

The 12-month US T-Bill yields over 2% (the 1-year BoT yields 0.2% and the German Bund has a negative yield). Up to two-year maturities, the gap is wide, then it gradually narrows, because recently in the euro area yields have risen a lot in anticipation of a rate hike by the European Central Bank, which, with the latest inflation spikes, will not be able to remain inactive.

"The dollar," continues Galli, "is a safe currency and guarantees higher yields than those in the euro area. The rate differential between the United States and Europe will remain even with ECB hikes, because inflation is higher across the Atlantic. Moreover, in times of uncertainty like the current one, the US currency has greater appeal."

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