Do hedged Swiss investors underestimate the attractivness of eurozone investments?
Many Swiss investors have been tempted to overlook European markets in favour of the US. Our analysis shows this to be an error of judgement.
In recent times, euro assets have been offering a higher yield than dollar assets on a currency-hedged basis. In this paper, we compare currency hedged yields as well as look at the size and diversification potential of corporate bonds, infrastructure debt and direct real estate markets in Europe and the US.
Given the low yields on Swiss fixed income securities and the limited investment universe, Swiss investors are pushed to invest internationally. However, the inclusion of foreign assets in a portfolio adds complexity — currency-hedging considerations must be taken into account — which can dramatically alter the attraction of a given investment. A simple comparison of local currency yields can therefore mislead and result in sub-optimal portfolio allocations.
In the first part of this paper, we investigate the impact of currency hedging on the yields available on euro (EUR) and US dollar (USD) corporate bonds, infrastructure debt and direct real estate from the perspective of a hedged Swiss investor. This allows investors to make a meaningful comparison between euro and dollar-denominated assets. In the second part, we compare the respective investment universe and its diversification potential.
Comparison of expected hedged yields
Figure 1 compares the local currency and CHF-hedged yields of corporate bonds, infrastructure debt and direct real estate. Hedged yields are calculated by adjusting local currency yields with the expected hedging costs implied by foreign exchange (FX) forwards. We show hedged yields using three-month, two-year and five-year FX forwards. Even though the two- and five-year forwards are rarely used in practice, they are informative on the market’s expectation on the evolution of the short-term hedging costs. The two-year timeframe is the most meaningful as a three-month window is too short to take account of likely near-term changes in the cost. The five-year figure, on the other hand, is subject to significant uncertainty. Given that actual hedging costs from a standard strategy of rolling over short-dated forwards are unknown in advance, we refer to these yields as expected hedged yields.
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