Peeking Through the Hedge

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Peeking Through the Hedge

2/24/2026

How currency hedging can impact our portfolio risk

Robert Bush

DWS Research Institute

Here at DWS we have devoted an extraordinary amount of time to analyzing the role that currency plays in a portfolio. And we have shared our headline thoughts on this topic with our clients, and the industry more broadly. However, the chart below shows one of our more esoteric findings.

Along the x-axis is the hedge ratio. Effectively this is the amount of currency risk that we are assuming one is removing from an international allocation. So, on the left, 0% means that the investor is removing none of the currency risk, and is fully unhedged, and, on the right, 100% means that they are fully hedging all currency risk in their foreign holdings. The y-axis shows portfolio risk (using arbitrary numbers of 16% volatility for equity, and 10% volatility for currency).

Figure One: A Portfolio’s Risk Reduction vs The Hedge Ratio

Source: DWS Investment, as of 10/2025

This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. Past performance is not indicative of future returns. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect.

Why is this chart so powerful for investors? It is because of its shape. Notice that the line is a curve with a steeper downward slope on the left, than on the right. This means that even some currency hedging should help to reduce risk. And that the most risk reduction comes as you start to hedge (not as you complete the hedge). In other words, the rate of risk reduction is not proportional to the hedge ratio - you likely will get more bang for your buck (more risk reduction per unit of hedge) at the beginning than at the end.

Of course, we’d be the first to concede that the risk reduction numbers may appear modest, but keep in mind that finance is a fight for every basis point. And, given the conditions that prevail today for US investors (and have done for more than a decade) in which the cost to hedge developed market currency is very low, we would argue that these are basis points that shouldn’t require too much of a struggle.

Peeking Through the Hedge

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