SKN | What Safety Really Costs: How Currency Hedging Weighs on Long-Term Portfolio Returns

Currency hedging is often viewed as a prudent way to reduce risk, particularly for investors seeking stability in uncertain markets. Yet for many long-term portfolios, especially those exposed to the U.S. dollar, this perceived safety can quietly erode returns. Understanding how hedging works—and when it truly adds value—is increasingly important for investors, banks, and wealth managers navigating a shifting interest rate environment.

Understanding Currency Hedging in Simple Terms

At its core, currency hedging is a financial technique used to protect investments from exchange rate movements. Banks and asset managers typically use forward contracts or derivatives to lock in an exchange rate between two currencies. While this can reduce short-term volatility, it also introduces costs linked to interest rate differences between countries. When U.S. interest rates are higher than those in Switzerland, for example, hedging U.S. dollar exposure into Swiss francs often comes with a negative carry that reduces overall returns.

How Hedging Impacts Investors and Businesses

For individual investors, the long-term impact of hedging can be significant. Equity portfolios that are globally diversified already benefit from exposure to multiple economies and currencies. Adding a currency hedge may limit upside potential without meaningfully reducing risk. Businesses face similar trade-offs. Corporations with international revenues often hedge to stabilize cash flows used for expenses such as payroll, credit servicing, or mortgage obligations. While this can improve predictability, it may also increase financing costs over time if interest rate differentials persist.

Implications for Banks and the Credit System

Banks play a central role in offering hedging products and advising clients on risk management strategies. Regulatory frameworks require institutions to clearly disclose hedging costs and risks, particularly as customers increasingly use digital banking platforms to manage investments. From a competition standpoint, banks that provide transparent, data-driven guidance can differentiate themselves. Hedging also affects the broader credit system: when capital is tied up in low-yield, hedged positions, it can limit banks’ ability to deploy deposits into higher-return loans or productive credit opportunities.

Broader Economic Trends and Future Outlook

The global economy has entered a period where interest rate gaps are wider and more persistent than in the past decade. This reality makes automatic hedging less attractive for long-term investors. Instead, selective hedging—aligned with specific cash flow needs—may become the norm. As financial technology evolves, banks are likely to integrate smarter analytics into checking account and investment platforms, helping clients assess whether hedging truly improves outcomes.

Closing Insights
Currency hedging is not inherently good or bad; its value depends on time horizon, interest rate conditions, and financial goals. Investors should question reflexive hedging and focus on total return, not just perceived safety. For banks, the opportunity lies in educating clients and aligning hedging strategies with real economic needs. Over the long run, disciplined diversification often proves more powerful than trying to eliminate every source of risk.