Example portfolio: Currency hedge

Exchange Traded Products (ETPs) can be used as a complement to a portfolio to hedge a long-term position. In an article series, Anna Svahn and Karl-Mikael Syding will go through four examples of how you can use this type of instrument in managing your portfolio.

Leverage products can be used, among other things, on the following occasions:
- Short-term hedge or boosting of existing long-term position in a particular event     
- Before planned news     
- After an overreaction to a news item  

Portfolio strategy

A currency hedge is used in a portfolio of assets to "translate" a return in one currency class to another currency. For example, if you think your Amazon shares will go up in price and you want that increase in SEK instead of USD, then you need to sell dollars and buy kronor for the same amount you invested in the share. You can do this by borrowing dollars and buying kronor, or by buying an instrument that gives a corresponding development. 

Another way of expressing it is to “hedge”, i.e. to protect one's investment against unwanted currency movements by taking a currency position that benefits from the currency going in the wrong direction. 

Currency hedge example

One way to use currency hedges is if, for example, through your equity portfolio you have the most export-dependent (and therefore dollar-exposed) industrial companies such as Atlas Copco, Sandvik, SKF. If you fear that the dollar will weaken, for example in connection with central bank decisions or macroeconomic statistics, you can then secure the portfolio with instruments that rise when the dollar falls against the krona.

Another way of exposure to currencies is as a direct investment in the movement of one currency relative to another. Just as you can buy gold because you think it will rise in price in SEK, so you can buy e.g. GBP, EUR or USD if you believe that the price in SEK will rise, whether you see it as a hedge of an existing portfolio or a pure exposure to the currency itself.

Recent example

The dollar (9.39 on 12 December 2019) has fallen quite a bit against the krona during October, November and December. This is the biggest decline in two years, when a bottom was set at around SEK 7.80 per dollar before the rally in 2018 and 2019 which took the dollar to SEK 10.

The fall in the dollar, the strength of the krona, in the autumn has coincided with the Swedish Riksbank signaling a desire to raise the policy rate to zero percent. In addition, President Trump's national law is approaching, at the same time as China has launched a large-scale purge of Western IT-related hardware and software, so there may be reason to believe in further weaker dollars in the near future. Technically, the dollar has also broken down during both its short trend line and below several important moving averages. After all, it is a bit down to the nearest support of between 9.00 and 9.25.

There are many reasons to believe in a continued strong dollar in the slightly longer term. The United States have the strongest and most dynamic economy in the world. The dollar is where capital usually flows only when the global economy weakens. There is a dollar shortage in the euro-dollar system, i.e. in practice, banks outside the US have lent more dollars than they have access to, which can create a "short squeeze" that pushes up the dollar exchange rate.

In the short term, however, it is not unreasonable to believe in a continuation of the short negative trend that has been going on for 10 weeks. This means that if you have a large dollar exposure through, for example, gold, US shares or export-dependent Swedish industrial companies, it may be wise to hedge the downside in dollars by shortening it against SEK.

If, on the contrary, you have most assets in SEK, then you can think about what is a good time to hedge against a new strong period for USD going forward. It may be relevant in a couple of months, but you never know. It can go faster than you think.