Currency Hedging Framework for EAFE Equities

This technical report discusses the performance of currency hedging for EAFE equities over the past decade, focusing on the MSCI EAFE Currency Hedged and Unhedged Indices. It outlines the significant outperformance of the hedged index, which returned 138% compared to the unhedged index's 53%. The report attributes this outperformance to the strengthening of the US Dollar and the attractive levels of currency carry generated by hedging. It also evaluates the volatility associated with both indices, noting that the hedged index exhibited lower volatility, averaging 12.4% compared to 15.1% for the unhedged index. The report presents a currency hedging framework consisting of four components: currency spot return, currency carry, volatility of local equity and currency, and correlation between local equity and currency. Additionally, it discusses the challenges of forecasting currency spot returns and the implications of interest rate differentials on currency carry for US investors. The findings suggest that currency hedging can mitigate risks associated with international equity investments.