Bond funds hedge currency risk, equity funds speculate

The study introduces a measure of funds' de facto currency risk exposure, derived from the sensitivity of fund returns to exchange rates after accounting for underlying asset returns.

This approximation overcomes data shortages on currency derivatives.

It reveals marked differences between bond and equity funds: bond funds consistently maintain high and stable hedge ratios, often close to 100% of their exposures.

In contrast, equity funds exhibit much lower and highly volatile hedge ratios, suggesting an opportunistic approach to currency risk management.

This speculative behavior was evident in April 2025, when equity funds rapidly increased their hedge ratios ex post, selling dollars in forward markets and likely amplifying the dollar's depreciation following an unexpected breakdown of US dollar correlations.

Drivers for hedge ratio adjustments differ.

Bond fund hedge ratios, while stable, show some sensitivity to hedging costs, which are linked to interest rate differentials and directly impact fixed income returns.

For equity funds, hedging decisions involve a significant discretionary and speculative element, aligning with active FX overlay strategies where managers form views on future exchange rate directions.

This is supported by the close co-movement between equity funds' de facto hedge ratios and speculative currency positioning of non-commercial traders in futures markets, indicating that equity funds minimise or maximise short dollar forward positions based on speculative bets.