Currency hedging for emerging market value portfolios

Abstract

In this thesis we study currency hedging from the perspective of a developed market (DM) value investor who invests in emerging markets (EM). We construct emerging market equity portfolios sorted on P/E, P/B, and both P/E and P/B. For all portfolios we look for evidence of a value premium, and analyze hedged and unhedged performance. Our analysis shows that value stocks outperform growth stocks, and that hedging a value portfolio can provide marginally higher risk-adjusted returns. The hedged portfolios do on the other hand provide potential diversification benefits due to lower correlation with their respective benchmarks. We conclude that there is a significant value premium, but currency hedging does not significantly outperform an unhedged strategy. For diversified portfolios consisting of 50% global stocks and 50% emerging markets value stocks, risk adjusted returns are lower than for the undiversified counterparts. However, in this scenario currency hedging emerging markets can provide significantly higher risk-adjusted returns.