Why the FT published our letter: “It’s wrong to look at FX Hedging as a Cost”

Currency hedging remains a crucial yet frequently misunderstood aspect of modern portfolio management. A letter written by Haakon Blakstad, CCO at Validus Risk Management and published in the Financial Times under the title “It’s wrong to look at FX hedging as a cost” addressed this persistent misconception.

The Cost Misconception

Too often, FX hedging is described as a cost - an expense that acts as a drag on returns. This framing positions foreign exchange risk management as an afterthought rather than an integral part of portfolio construction. In reality, treating FX hedging solely as a cost ignores the mechanics of forward pricing and risks overlooking strategies that can both reduce volatility and enhance long-term returns.

The Interest Rate Differential Reality

Forward rates are determined by interest rate differentials between currencies. Without this mechanism, arbitrage opportunities would arise. For example, an investor could borrow cheaply in one currency, convert to another with higher rates, and hedge the exchange risk for risk-free profit.

In practice, this means that when hedging exposure from a lower-yielding into a higher-yielding currency, the forward rate becomes more favorable than today’s spot. Rather than paying for protection, the investor is compensated for the interest gap, shifting the hedge from an operational cost to a value-adding strategy.

Impact: Moving Beyond Cost

The value-add of this hedge strategy is clear: It captures the interest that would be earned by purchasing and holding the higher-yielding currency immediately. So, sophisticated investors therefore discuss the impact of hedging rather than defaulting to a “cost-based” terminology.

At Validus, our responsibility extends beyond protecting client assets to strategically enhancing portfolio construction to optimize performance. Foreign exchange hedging, when properly understood and implemented, represents a tool that can simultaneously mitigate risk and capture opportunities.

The Costs of Being “Hedge-Adverse’’

The hidden costs of a “hedge-adverse” approach may be the opportunities we never pursue, the strategies we never consider, and the value we never capture. In today's volatile markets, an approach to currency hedging that over-indexes on cost can be expensive for investors.

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