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FX Effects: Currency Considerations for Multi-Asset Portfolios

Juan Mier, CFA, Vice President, Portfolio Analyst

The impact of currency hedging for global portfolios has been debated extensively. Interest on this topic would appear to loosely coincide with extended periods of strength in a given currency that can tempt investors to evaluate hedging with hindsight. The data studied show performance enhancement through hedging is not consistent. From the viewpoint of developed markets currencies—equity, fixed income, and simple multi-asset combinations—performance leadership from being hedged or unhedged alternates and can persist for long periods. In this paper we take an approach from a risk viewpoint (i.e., can hedging lead to lower volatility or be some kind of risk control?) as this is central for outcome-oriented asset allocators.

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“The cognitive bias of hindsight is followed by the emotion of regret. Some portfolio managers hedge 50% of the currency exposure of their portfolio to ward off the pain of regret, since a 50% hedge is sure to make them 50% right.”

—Hedging Currencies with Hindsight and Regret, Statman (2005)

Why Hedge FX?Foreign currencies (FX) are a means of exchange for global trans-actions. However, FX plays a key function in global investing both as an asset class in its own right and as a component of financial asset returns. Very simply, global investors need to convert foreign currency-denominated investments into their portfolio’s base currency. This activity can lead to gains or losses that may be totally unrelated to a security’s fundamentals. A hedged position can remove the losses when the currency moves adversely, but also mute gains if the currency moves favorably.

While we recognize currency effects can be considered within fundamental security analyses—by adjusting valuation model parameters—it is also an important concern at the portfolio construction level or for institutional asset owners. Hedging has been a widely discussed subject for many years and interest in the topic would appear to fluctuate along with major currencies’ moves.

We are approaching this paper by focusing on currency hedging as a potential tool for portfolio risk control. While we believe that value can be added from active currency management1 we need to separate the return generation goals from the risk control objec-tives—as these two are competing goals. In other words, we will look at asset returns where hedging is “passive” and there is no tactical timing element to put in the hedges or to take active views on certain currency pairs.

The Debate on FX Hedging in Global Portfolios Is Not NewA study from the 1990s2 summarizes theoretical and empirical papers up to that point. The solutions reviewed spanned those advocating hedging all FX exposures—due to the belief of zero expected returns from currencies—to those advocating no hedging—due to mean reversion in the medium-to-long term—and lastly those that proposed something in between—a range of values for a “universal” hedge ratio. Later on, in the mid-2000s the aptly titled Hedging Currencies with Hindsight and Regret 3 took a behavioral approach to describe the difficulty and behav-ioral biases many investors face when incorporating currency hedges into their asset allocation.

In addition to academics, many industry practitioners have tackled the FX hedging dilemma.4 Our study explores this question drawing from similar methodologies and benefits from the data availability of hedged indices for both equity and fixed income, data, which to our knowledge, was not extensively avail-able in the past. As such, we take a data-driven approach to glean insights from the historical risk-return profiles in equities, fixed income, and simple 50/50 multi-asset portfolios.

Data and MethodologyThe analysis and results center on global developed markets equity and fixed income indices. Results are calculated from the point of view of the following developed markets currencies: US dollar (USD), Australian dollar (AUD), British pound (GBP), Canadian dollar (CAD), euro (EUR), Japanese yen (JPY), and Swiss franc (CHF). Importantly, EUR returns for both equity and fixed income are only available since its inception in 1999. The main reasons for excluding emerging markets is insufficient availability of data. Perhaps more importantly, hedging emerging markets currencies in practice can be more expensive and results using cost-free index data may underestimate actual results by a greater margin than in the developed world.

The time period analyzed spans almost three decades of monthly returns and is restricted by our availability of hedged index data. In equities, we cover the period from December 1987 to December 2017 based on the MSCI World Index. We utilized price returns only, given that total return hedged indices have a shorter history. In cases where hedged indices were not avail-able, we used the “local” return calculated by MSCI. This “local” return represents the theoretical performance by removing all currency effects. This differs from the hedged returns calculation where a specific hedge impact (calculated by MSCI as a hypo-thetical 1-month forward contract) is used to adjust the returns in a given currency. In terms of performance, hedged and “local” returns will be different, but in terms of risk their profiles are virtually the same. With this in mind, using local for risk-based analysis is appropriate wherever hedged indices are missing (we

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ended up using local returns for the CAD and CHF equity cases). In fixed income, we relied on unhedged and hedged currency versions of the Bloomberg Barclays Global Aggregate Bond Index5 which goes back to January 1990. For multi-asset results—combining equity and fixed income—we used 50/50 combinations of the respective equity or fixed income indices.

All of our data are gross of fees and exclude transaction costs. In addition, we have focused entirely on index data so the impact of fully hedged returns relies on each currency’s weights in the benchmarks. In practice, an investor’s portfolio could be more home biased or have different active views on regions that would affect the sizing of hedges and the outcome. However, we believe using standardized, transparent benchmarks is an adequate baseline approach.

Within each currency, we calculated a monthly series of relative returns of unhedged minus hedged indices for different rolling periods to then obtain performance and volatility. While this is a straightforward approach, very often we see results presented for the entire analysis period or one to two subperiods, which suffer from bias to the start date chosen and mask entry point risk. Given our risk focus, we think looking at rolling volatility can give investors an idea of times when risk may be higher/lower than what is masked by a single, full period summary number. Selected results are presented in the exhibits and expanded in the Appendix. We recognize there are other interpretations of port-folio risk6, but we believe using the standard deviation of returns is a suitable approach.

For the remainder of the paper, references in exhibits will be labeled with a currency code only, but it represents the return of the underlying index. Hence, if we are talking about equities and label a data point or series “USD,” it means the US dollar return of the MSCI World Index or “USD H” for the hedged USD return of the MSCI World Index. Similarly, in fixed income, USD would be the Bloomberg Barclays Global Aggregate Index and USD H would be the hedged version of that index.

Equity: Hedging May Not Be Justified from a Risk Standpoint The contribution of currency effects to equity performance is an important consideration. As a result, it is tempting to view currency hedging as a possible return enhancer in equity portfo-lios. However, a hedging decision can have a positive or negative impact depending on the direction of the currency fluctuation. This leaves portfolio managers with the added complexity of determining hedging entry points. For example, while hedged USD equities slightly outperformed unhedged equities (+5.9% versus +5.6%) over the 1987–2017 period, this is not very

useful in practice (i.e., maintaining a 30-year hedging program). Therefore, looking at rolling periods of relative returns (unhedged minus hedged) gives us a better sense of different regimes when hedging has been effective (Exhibit 1). Not only do relative returns change direction, but also the spread can be significant—exacerbating the behavioral “regret” risk of being on the wrong side of the FX hedge.

Exhibit 1Timing Performance from Currency-Hedged Equities Can Be Very Challenging

Rolling 1Y, Annualized

-15

-10

-5

0

5

10

20172013200920052001199719931989

USD minus USDH (%)

Unhedgedoutperforms

Hedgedoutperforms


USD minus USDH (%)

-9

-6

-3

0

3

6

20172013200920052001199719931989

Unhedgedoutperforms

Hedgedoutperforms


USD minus USDH (%)

-6

-3

0

3

6

20172013200920052001199719931989

Unhedgedoutperforms

Hedgedoutperforms

As of December 2017

Source: Bloomberg, FactSet

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If past results are a rough guide to future behavior one could argue for hedging global equities for Swiss investors and going unhedged for Japanese investors based on the 3-year and 5-year return results (Exhibit 2). However, overall results are closer to “50/50” in most cases, highlighting the difficulty of getting the hedging decision right. This is especially relevant in 1-year rolling periods, which would be a more typical strategic hedging time horizon in practice.

With this in mind, we think it is more constructive to approach currencies from a risk viewpoint for equity portfolio construction decisions. In other words, does removing currency risk lower a portfolio’s volatility? At first glance, removing the effect of currencies should lead to lower volatility. However, this overlooks that the interaction between equity and currency returns will also drive the volatility.

Looking at 3-year rolling volatility we can see periods where hedging actually increases risk (Exhibit 3) for AUD, CAD, and EUR-based equity investors. While this happens especially in times of stress (i.e., 2008–2009) it also appears elsewhere in the time series. By hedging, we are removing assets (in this case currency) that can provide diversification benefits. The Global Financial Crisis helps illustrate this further. Taking the AUD as an example, both global equities and the Australian dollar fell at the same time “safe haven” currencies such as the JPY, CHF, and the USD strengthened (to a certain extent) in this period of stress. As a result, with hedging in place, the AUD-based global investor is removing the “safe haven” diversification effects and therefore obtaining a more volatile asset than by remaining unhedged. This can be seen in the right panel charts of Exhibit 3, where the correlation of hedged equities to the local currency spikes higher relative to unhedged equities. As a final point on equities, multinational companies also undertake FX hedging programs, which further complicates measuring the effect of a hedging overlay program.

Disentangling this effect will require deep knowledge of the company fundamentals and analyzing individual historical return patterns to gauge if a given stock is already acting as an FX-hedged return series due to the hedging activities of the company itself. This is not an issue in fixed income, where a given bond is representing a cash flow stream in a determined currency.

Exhibit 2Summary Results for Equity: Unhedged vs. Hedged

For the period 1987–2017, monthly observations. Blue = unhedged outperforms; yellow = hedged outperforms

1Y Rolling "win-loss"

% Unhedged outperforms

("win")

AUD - AUD H

1 Year

38

CAD - CAD H 50

CHF - CHF H 40

EUR - EUR H 47

GBP - GBP H 45

JPY - JPY H 53

USD - USD H 50



("win")

AUD - AUD H

3 Year

5 Year

45

CAD - CAD H 55

CHF - CHF H 33

EUR - EUR H 51

GBP - GBP H 42

JPY - JPY H 63

USD - USD H 53



("win")

AUD - AUD H

5 Year

41

CAD - CAD H 50

CHF - CHF H 21

EUR - EUR H 57

GBP - GBP H 38

JPY - JPY H 69

USD - USD H 54

As of December 2017


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Exhibit 3Currency-Hedged Equities Can Have Higher Volatility in Certain Cases

3Y Rolling Volatility 3Y Rolling Correlation

AUD HAUD(%)

0.05

0.10

0.15

0.20

0.25

2017201320092005200119971993

3Y Rolling Correlation(%)

-0.8

-0.4

0.0

0.4

0.8

2017201320092005200119971993

AUD Exchange Rate to AUD AUD Exchange Rate to AUD H

3Y Rolling Volatility 3Y Rolling Correlation3Y Rolling Volatility

(%)

0.05

0.10

0.15

0.20

0.25

2017201320092005200119971993

CAD Local (%)

-0.8

-0.4

-0.0

0.4

0.8

2017201320092005200119971993

CAD Exchange Rate to CAD CAD Exchange Rate to Local

3Y Rolling Volatility 3Y Rolling Correlation

(%)3Y Rolling Volatility

0.05

0.10

0.15

0.20

0.25

2017201320092005200119971993

EUR EUR H (%)

-0.8

-0.4

-0.0

0.4

0.8

2017201320092005200119971993

EUR Exchange Rate to EUR EUR Exchange Rate to EUR H

As of December 2017

CAD hedged returns are using the local index return. Correlation charts are computed using the monthly changes in the nominal narrow effective exchange rates and the unhedged/hedged returns as labeled.

Source: BIS, Bloomberg, FactSet, Haver Analytics

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Fixed Income: Structurally Higher Volatility of a Currency Can Justify HedgingFrom a performance perspective, hedged global fixed income shows some advantages versus unhedged, but this is not strong enough to be conclusive in all currencies and in terms of rolling periods (Exhibit 4). Importantly, this assertion relates to fully hedged passive, costless indices.

In practice, we think active currency management in fixed income portfolios can add value, but that topic is beyond the scope of this research.

However, from a volatility perspective hedging FX leads to lower volatility for all currencies we studied. This follows from the observation that local fixed income returns have lower volatility than the FX returns have. For example, US bonds have a historical volatility of 3.7% and the USD effective exchange rate has 5.4% for the period 1987–2017. Japanese bonds have a volatility of 3.4% and the JPY effective exchange rate has 8.4%7. So, when we look at global fixed income markets the mix of currencies will introduce fluctuations, leading to higher volatility for unhedged versions of global fixed income (Exhibit 5).

Thus far, we have evaluated fully hedged indices. From our data, we can draw an interesting observation related to the pace of volatility reduction related to the share of a fixed income portfolio that is hedged. The reduction in volatility slows down after approximately hedging 50% of the fixed income portfolio (Exhibit 6). The improvement in risk reduction is not as significant as one moves from 50% to 100% hedging versus moving from unhedged to 50% hedged. In other words, about 60% hedging achieves three-fourths of the possible risk reduction. We approximated the percentage hedge by calculating weighted returns of the unhedged and fully hedged indices and moving these weights incrementally.

The results are driven in part by the interaction of the weight of each currency in the index and the unhedged volatility. For instance, the USD is the largest weight and has the flattest line—reflecting slower rate of risk reduction, even at 0% hedged there is already a large share of USD in the benchmark. In contrast, the AUD risk falls sharply as it has a smaller weight in the index than the USD has, meaning that a bigger proportion of FX risk is being removed as the hedge increases. Overall, we think these observations have practical implications for benchmark-aware global fixed income portfolios, as it can be used as a rough guide to think about sizing the hedges.

Exhibit 4Hedged Global Fixed Income Has Some Performance Advantages, but Results Are Inconclusive

For the period 1987–2017, monthly observations. Blue = unhedged outperforms; [yellow] = hedged outperforms



("win")

AUD - AUD H

1 Year

37

CAD - CAD H 41

CHF - CHF H 41

EUR - EUR H 45

GBP - GBP H 40

JPY - JPY H 51

USD - USD H 47



("win")

AUD - AUD H

3 Year

5 Year

41

CAD - CAD H 35

CHF - CHF H 28

EUR - EUR H 44

GBP - GBP H 35

JPY - JPY H 58

USD - USD H 51



("win")

AUD - AUD H

5 Year

29

CAD - CAD H 23

CHF - CHF H 13

EUR - EUR H 43

GBP - GBP H 37

JPY - JPY H 76

USD - USD H 48

As of December 2017

Source: Bloomberg

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Multi-Asset Portfolios: Interaction Gets More ComplexAs an approach for a basic multi-asset proxy, we ran 50/50 equity/fixed income portfolios with monthly rebalancing. In our opinion, this provides an adequate baseline to evaluate the most basic form of multi-asset investing. We then applied the same analysis we had done separately for equity and fixed income—calculate rolling period performance and volatility.

In terms of performance, we once again cannot make a conclusive statement with regards to hedging for every period and currency (Exhibit 7). Except the cases for JPY and CHF 5-year rolling returns, where unhedged and hedged favor each currency

Exhibit 6Risk Reduction Rate in Fixed Income

Volatility (%)

Hedged (%)

2

4

6

8

10

1009080706050403020100

USD EUR AUD JPY

CHF CAD GBP

For the period January 1990 to December 2017

Source: Bloomberg

Exhibit 7Unhedged vs. Hedged Performance in Multi-Asset Portfolios

For the period 1990–2017, monthly observations. Blue = unhedged outperforms; [yellow] = hedged outperforms



("win")

AUD - AUD H

1 Year

37

CAD - CAD H 45

CHF - CHF H 36

EUR - EUR H 46

GBP - GBP H 44

JPY - JPY H 50

USD - USD H 51



("win")

AUD - AUD H

3 Year

5 Year

45

CAD - CAD H 40

CHF - CHF H 22

EUR - EUR H 48

GBP - GBP H 40

JPY - JPY H 60

USD - USD H 52



("win")

AUD - AUD H

5 Year

34

CAD - CAD H 26

CHF - CHF H 5

EUR - EUR H 49

GBP - GBP H 39

JPY - JPY H 75

USD - USD H 50

As of December 2017


Exhibit 5Hedged Global Fixed Income Has Lower Historical Volatility

Rolling 3Y Volatility, Annualized

(%)

0

2

4

6

8

2017201320092005200119971993

USD USD H

(%)

0

5

10

15

2017201320092005200119971993

JPY JPY H

As of December 2017

Additional currencies shown in the appendix

Source: Bloomberg

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respectively. From a risk perspective, volatility for the entire period was indeed lower for fully hedged portfolios—generating better risk-adjusted returns. The case of Japan and Switzerland-based investors are where we see the biggest reduction in volatility via hedging. But in the case of the USD, results were very similar in both performance and volatility. However, when looking at rolling period of volatility, we do see some instances where the hedged solutions have higher risk (Exhibit 8). We have discussed only equity and fixed income combinations, but multi-asset portfolios can span other asset classes. The same framework can evaluate the FX impact on other assets (see callout: FX Considerations for Commodities). What are investors’ options given that most of the evidence thus far appears inconclusive with regards to a general statement about hedging as risk control? Especially, for USD-based investors the decision to hedge correctly based on past data appears as good as a coin toss. However, the structure of multi-asset portfolios allows for other tools for managing risk.

Volatility Targeting: Asset Allocation as a Risk Control Tool

Risk awareness is a central feature of multi-asset portfolios, where a focus on outcomes becomes vital for evaluating results. At first glance, removing FX exposure through hedging would appear to be a good risk mitigation tool. However, as we have outlined, this is true in fixed income investments but not in equities or in basic multi-asset portfolios.

Informed by our internal research (Predicting Volatility and Dynamic Volatility Targeting), volatility targeting through dynamic asset allocation is an effective tool for controlling risk and smoothing a return pattern.8 Hence, historical risk targets from FX-hedged solutions can be met with unhedged solutions through asset allocation.

To evaluate this, we took the realized long-term volatility of a USD hedged 50/50 equity/fixed income blend (7% annualized 1987–2017) as our volatility target. We obtained equity and fixed income weekly weights through medium- and short-term volatility optimizations for the period 2000 to 2017.9 This volatility-controlled approach results in an improved Sharpe ratio: 0.24 for the hedged 50/50 blend versus 0.38 for the unhedged targeted-volatility portfolio.10 In addition, we can see a smoother volatility pattern, particularly in times of market stress (Exhibit 9). Of course, the hedged approach and volatility targeting method are not mutually exclusive. These two can potentially combine to meet other risk outcomes. However, we want to highlight that on its own, volatility control through dynamic asset allocation can be a powerful portfolio construction tool that directly seeks a risk outcome. On the other hand, currency hedging on its own is not as effective at fine-tuning a volatility target.

Exhibit 8Hedged Portfolios Can Have Higher Risk at Certain Points

3Y Rolling Volatility

(%)

0

5

10

15

2017201320092005200119971993

AUD HAUD

(%)

0

5

10

15

2017201320092005200119971993

EUR EUR H

(%)

0

5

10

15

2017201320092005200119971993

CAD CAD H

As of December 2017

CAD hedged returns are using the local index return.


https://www.lazardassetmanagement.com/us/en_us/research-insights/investment-research/22430-Predicting-Volatility

https://www.lazardassetmanagement.com/docs/-m0-/10211/DynamicVolatilityTargeting_LazardResearch_en.pdf

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ConclusionThe impact of currency hedging in global portfolios has been debated extensively. We believe that taking a risk control viewpoint to this dilemma helps frame investment decisions in a more constructive way. The flipside would be focusing on return enhancement and therefore the timing of hedges. We believe that policies that aim to hedge to improve performance are challenging to time correctly, as our results show. Instead, FX specialists are needed if the intention is to add value through active currency management. We also recognize that institutional or regulatory constraints may force some asset allocators to fully or partially hedge their exposure to meet requirements.

For asset allocators, a helpful approach would be to focus on the risk characteristics—rather than performance—within FX-hedged portfolios. While some performance advantages may emerge in certain cases, we usually found this in our 5-year rolling period analysis, which may not be practical to set up. Understanding the interaction of the portfolio base currency with a given global asset class is critical—in some cases hedging FX exposure can amplify risk. If FX hedging is not an institutional requirement, an effective method of risk control can be through asset allocation with dynamic volatility targeting.

Exhibit 9Comparing Volatility Targeting (Unhedged Blend) vs. a Hedged Blend

(%)52-Week Rolling Volatility

0

5

10

15

20

201720152013201120092007200520032001

7% Volatility Target USD H

For the period May 2000 to December 2017

For illustrative purposes only. This data does not represent any product or strategy managed by Lazard. USD H uses MSCI World Local as the equity component due to data frequency.

Source: Bloomberg

FX Considerations for CommoditiesCommodities have very different FX implications when compared to those of equities and bonds. Globally, the prices of investable commodities are quoted in USD. However, commodities come from many different locations. Therefore, there constantly are interactions between the local currency, the commodity price, and the USD itself. Making sense of these interactions requires a specialized skillset.

In general, commodities provide a natural hedge to USD fluctuations. Since they are priced in USD, a stronger dollar boosts the profits of commodity exporters. When the dollar weakens, commodity demand in non-dollar countries strengthens. With this in mind, constructing a commodities portfolio would not implement FX hedges as part of the fundamental views.

However, from the point of view of asset allocation, a commodities allocation must take into account the FX translation effect. In other words, evaluating a global commodities exposure (priced in USD) as it is converted to the domestic currency. It follows that asset allocators must understand if their portfolio seeks an exposure to global commodities simply translated to local currency—in which case the solution is unhedged. On the other hand, if one seeks to obtain the USD-based dynamics of a commodities exposure, the solution can be to hedge and remove the FX translation effect.

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Appendix Equity

Fixed Income

Results for the period 1990–2017 (EUR, CAD, CHF since 1999)

USD USD H EUR EUR H AUD AUD H JPY JPY H CHF CHF H CAD CAD H GBP GBP H

Return (%) 5.9 6.1 3.9 4.2 5.9 8.5 5.0 3.9 2.1 3.0 3.1 4.9 6.8 7.6

Vol (%) 5.4 3.0 6.7 2.7 10.2 3.0 8.7 3.0 7.5 2.7 8.5 2.7 8.3 3.1


Results for the period 1987–2017 (EUR since 1999)

AUD CAD CHF EUR GBP JPY USD Local AUD H EUR H GBP H JPY H USD H

Return (%) 5.3 5.5 4.7 3.1 6.8 5.4 5.6 5.6 7.8 2.5 7.3 3.5 5.9

Volatility (%) 13.2 12.6 16.7 14.2 14.7 17.4 14.7 13.7 13.9 14.0 13.7 13.6 13.7


Volatility is consistently lower in hedged fixed income – 3Y Rolling Volatility

(%)

0

2

4

6

8

2017201320092005200119971993

USD USD H (%)

0

5

10

15

2017201320092005200119971993

JPY JPY H

(%)

0

6

12

18

2017201320092005200119971993

AUD HAUD

0

5

10

15

2017201320092005200119971993

GBP HGBP(%)

11

3Y Rolling Volatility

0

5

10

2017201320092005200119971993

EUR EUR H(%)

0

4

8

12

2017201320092005200119971993

CHF CHF H(%)

(%)

0

5

10

15

2017201320092005200119971993

CAD CAD H

Source: Bloomberg

Multi-Asset

Results for the period 1990–2017 (EUR, CAD, CHF since 1999)

USD USD H EUR EUR H AUD AUD H JPY JPY H CHF CHF H CAD CAD H GBP GBP H Local

Full Period, ann (%) 5.7 5.7 3.6 3.7 5.7 7.7 4.8 3.5 1.9 3.2 2.9 4.2 6.6 7.1 5.7

Vol (%) 8.5 7.1 8.2 6.9 9.3 7.2 11.9 7.1 10.1 6.8 7.3 6.8 9.6 7.1 7.1


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Currencies

Nominal narrow effective exchange rates

NEER Index, December 1987=100

60

100

140

180

2017201520132011200920072005200320011999199719951993199119891987

USD GBPCHF JPYEUR CADAUD

NEER for the euro prior to 1999 is calculated using a weighted average of legacy currencies.

Source: BIS

Results for the period 1987–2017 (EUR since 1999)

AUD CAD EUR JPY CHF GBP USD

Volatility (%) 7.6 5.4 4.8 8.3 4.6 5.5 5.4

ReferencesBrandes Institute. 2007. “Currency Hedging Programs: The Long-Term Perspective.”

Gastineau, Gary L. 1995. “The Currency Hedging Decision: A Search for Synthesis in Asset Allocation.” Financial Analysts Journal, May-June 1995.

Marra, Stephen. 2013. “Dynamic Volatility Targeting.” Lazard Investment Research.

Marra, Stephen. 2015. “Predicting Volatility.” Lazard Investment Research.

Pojarliev, Momtchil and Richard M. Levich. 2012. “A New Look at Currency Investing.” The Research Foundation of CFA Institute, 21 December 2012.

Peterson LaBarge, Karin. 2010. “Currency management: Considerations for the equity hedging decision.” Vanguard.

Peterson LaBarge, Karin. 2014. “To hedge or not to hedge? Evaluating currency exposure in global portfolios.” Vanguard.

Statman, Meir. 2005. “Hedging Currencies with Hindsight and Regret.” The Journal of Investing.

Thomas, Charles and Paul M. Bosse. 2014. “Understanding the ‘hedge return:’ The impact of currency hedging in foreign bonds.” Vanguard.

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LR31011

Notes1 For a comprehensive discussion of this topic see: Pojarliev and Levich (2012).

2 Gastineau (1995)

3 Statman (2005)

4 Peterson (2010, 2014), Thomas (2014), Brandes (2007)

5 The Bloomberg Barclays Global Aggregate Bond Index provides a broad-based measure of global investment-grade fixed-income debt markets, including government-related debt, corporate debt, securitized debt, and global Treasury. The index is unmanaged and has no fees. One cannot invest directly in an index.

6 These would include drawdowns, tracking error, factor exposures that can arise from foreign securities, or other characteristics.

7 Volatility based on monthly returns. US bonds = Bloomberg Barclays US Aggregate Index; USD effective exchange rate = nominal narrow effective exchange rate from the Bank of International Settlements; Japan bonds = FTSE Japan GBI Local Index; JPY effective exchange rate = nominal narrow effective exchange rate from the Bank of International Settlements. Source: Bloomberg, Haver Analytics

8 Marra (2013 and 2015)

9 Methodology: asset class weights are the result of 2 independent optimizations using the MSCI World Index and the Barclays Global Aggregate Index. One optimization looks at the last 6 months of weekly returns and the other looks at the last 22 days of daily returns. Both of these aim to minimize the tracking error with a 50/50 allocation of MSCI World/Global Aggregate while targeting 7% volatility using the aforementioned time periods. Whichever optimization has the lower allocation to equities is then used in the resulting allocation. Optimizations allow +/- 0.5% volatility relative to the 7% target. There can be cases when no weights are found by the process due to volatility over/under shooting the limits, in these instances all weight is put on fixed income or equity respectively. Other sporadic missing weights values were filled with the average of the previous and next weights.

10 Based on weekly data using 50/50 local instead of USD H for equity given that USD H is monthly. Monthly Sharpe using USD H is 0.25.

Important InformationPublished on 7 January 2019.

This document reflects the views of Lazard Asset Management LLC or its affiliates (“Lazard”) based upon information believed to be reliable as of 16 February 2018. There is no guarantee that any forecast or opinion will be realized. This document is provided by Lazard Asset Management LLC or its affiliates (“Lazard”) for informational purposes only. Nothing herein constitutes invest-ment advice or a recommendation relating to any security, commodity, derivative, investment management service or investment product. Investments in securities, derivatives and commodities involve risk, will fluctuate in price, and may result in losses. Certain assets held in Lazard’s investment portfolios, in particular alternative investment portfolios, can involve high degrees of risk and volatility when compared to other assets. Similarly, certain assets held in Lazard’s investment portfolios may trade in less liquid or efficient markets, which can affect investment performance. Past performance does not guarantee future results. The views expressed herein are subject to change, and may differ from the views of other Lazard investment professionals.

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Please visit www.lazardassetmanagement.com/globaldisclosure for the specific Lazard entities that have issued this document and the scope of their authorized activities.

Certain information included herein is derived by Lazard in part from an MSCI index or indices (the “Index Data”). However, MSCI has not reviewed this product or report, and does not endorse or express any opinion regarding this product or report or any analysis or other information contained herein or the author or source of any such information or analysis. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any Index Data or data derived therefrom.

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