US investors complacent about currency risk, says Merrill

A decade of US asset and currency outperformance has engendered complacency among US-based equity investors, according to Merrill Lynch’s foreign exchange strategy group.

Until recently, it has been a profitable strategy to either invest solely in domestic assets or leave international equity exposures unhedged, according to research by the strategy group, which is led by Yianos Kontopolous, New York-based chief global forex strategist at Merrill Lynch.But against the backdrop of a faltering US economy and uncertainty over the strength of the dollar, US investors may increase foreign allocations, and Merrill Lynch is urging them to either hedge their international exposure or manage their currency risk with care.

Between 1992 and 2001, the US equity market outperformed the MSCI world index by 25.7%, while the dollar appreciated by 27% - on a trade-weighted basis – over the same period.

Part of investors’ reluctance to embrace currency hedging could be explained by its impact on returns. Currency hedging would have reduced returns for Japan-based and European Union-based global equity investors over the period since 1995.