Investment Strategy
An FX Hedging Framework for a More Divergent World
Executive Summary
- Investing in assets outside one’s home market is an important part of building a diversified multi-asset portfolio. However, there is often disagreement about how best to manage the currency risks associated with doing so.
- In this piece, we outline J.P. Morgan Private Bank’s strategic approach to FX hedging the three major asset classes (fixed income, equities, alternatives), for investors with different base currencies.
- Analyses based on i) relative historical volatility between asset classes and exchange rates, and ii) J.P. Morgan’s forward-looking LTCMAs both argue for fully FX-hedging fixed income and lower-volatility alternatives. Foreign currency equity positions can be mostly left unhedged.
- We conclude by investigating whether recent correlation shifts between the U.S. dollar and risk assets requires a tactical deviation from the strategic approach in the near-term. We discuss implications for both USD and non-USD based investors.
Introduction
Investing in international assets outside one’s home market is a key part of building a diversified portfolio. Different geographic regions are at different stages of the economic cycle, facing different policy environments, presenting different thematic opportunities. While divergence between regions offers diversification benefits, however, it also brings currency risk.
There is often disagreement about how best to manage FX risk in global multi-asset portfolios. Some academic studies argue against FX hedging over a strategic horizon, based on the theory that exchange rates tend to be mean reverting over time. Others argue in favor of partially or even fully FX-hedging, depending on the currency and destination market – for example, one recent analysis found that consistent exposure to JPY and CHF—while fully hedging other currencies—was optimal.1
In this piece, we outline J.P. Morgan Wealth Management’s strategic approach to FX hedging the three major asset classes (fixed income, equities, alternatives) for investors with different base currencies. We conclude by investigating whether a tactical deviation from the strategic approach is called for given the U.S. dollar’s correlation with equities has become unstable relative to the past decade.
Our strategic approach to FX-hedging
The starting point for justifying any investment is an analysis of its impact on a portfolio’s risk-adjusted returns. Our approach to currency hedging operates in the same way: is the cost of hedging outweighed by the volatility-dampening and diversification effects, so that the risk-adjusted return of the portfolio is improved? Below we perform two separate analyses based on different datasets and methodologies and derive similar conclusions.
1. Analysis based on historical observations of relative asset volatility
Our first analysis looks at historical asset class volatility over the past 20 years2 to assess the volatility dampening effect of FX hedging. Table 1 shows that, regardless of base currency and destination market, the annualized volatility of fixed income returns has been consistently lower than exchange rate volatility (i.e. an FX-asset volatility ratio higher than 1). In other words, when a foreign-currency fixed income position is unhedged, the return is to a larger extent driven by currency moves instead of the underlying asset, undermining the purpose of holding the position in the first place. For this reason, our analysis argues for considering fully FX-hedging fixed income positions.3
The opposite is historically true for foreign currency equity allocations, where the standard deviation of equity returns consistently comes in above that of the relevant exchange rate. This is the case across base currencies and destination markets, as shown in Table 1. In other words, the volatility-dampening effect of FX-hedging foreign equity holdings has not been as impactful as in fixed income over this 20-year period, and thus it is harder to justify the associated cost.
What about alternatives? It depends. As shown in Table 2, the volatility of FX returns historically outweighs that of low-volatility alternative investments such as hedge funds, arguing for considering currency hedging them like fixed income investments. Whereas the opposite is true for alternatives with higher volatility, like private equity and real assets such as commodities or global real estate.4
All told, our analysis implies a baseline approach that involves hedging foreign-currency fixed income investments and low-volatility alternatives, and leaving international equity exposure unhedged.
2. Analysis based on J.P. Morgan’s Long-term Capital Market Assumptions (LTCMAs)
On top of the framework derived from relative historical volatility, we also want to look at something more forward looking - past performance is no guarantee of future results! – and that incorporates the impact of FX hedging on expected returns in addition to volatility. For that, we lean on the J.P. Morgan Long-term Capital Market Assumptions (LTCMAs). The LTCMAs represent the best thinking across J.P. Morgan Asset & Wealth Management and form the backbone of our strategic asset allocation decisions.
The tables below show projected annualized returns, volatility and Sharpe ratios across asset classes – both FX hedged and unhedged – for various base-currency investors. The far-right column shows whether assumed risk-adjusted returns would be improved or not by hedging the foreign currency investment, provided the LTCMAs prove accurate.5
We would make the following observations:
- The case for fully FX-hedging foreign bond investments is evident, as in the first analysis. Across a vast majority of base currencies, Sharpe ratios are meaningfully improved when cross-border fixed income investments are FX-hedged. For USD-based investors, the volatility-dampening effects of FX hedging are projected to outweigh the 20-50bps annual hit to returns, while for EUR- and GBP-based investors an FX-hedged foreign bond allocation both boosts projected returns relative to an unhedged investment and reduces portfolio volatility. Results are mixed for CHF-based investors as hedging costs are higher.
- The same is generally true for non-USD investors when it comes to relatively lower-volatility alternative investments like core infrastructure, timber and hedge funds. As above, we eschew an analysis for USD-based investors given most alternatives are priced in USD.
The story is more nuanced when it comes to equities.
Projected portfolio volatility declines when international equity allocations are FX-hedged, with the exception of Japanese equities (regardless of base currency) and U.S. equities for EUR- and GBP-based investors.
From a pure risk management standpoint, therefore, the LTCMAs imply that USD-based investors should consider leaving only Japanese equity allocations unhedged, while EUR- and GBP-based investors might be better off leaving both Japanese and US equity investments unhedged.
However, a complete framework requires an analysis of both returns and volatility. And once the impact on returns of FX-hedging is taken into account, the LTCMAs project little difference in risk-adjusted returns whether foreign equity allocations are hedged or unhedged – across most base currencies and destination markets.
For example, as shown in the table below, the LTCMAs project a USD-based investor holding FX-hedged European or UK equities would forgo 50-60bps of expected annual returns (given the USD’s anticipated mean reversion weaker over the long-term), largely offsetting the benefit to risk-adjusted returns of the associated decline in portfolio volatility. The opposite is true for EUR- and GBP-based investors holding U.S. equities, where FX-hedged returns are projected to be higher, but also more volatile.
All told, while the tables below show there are small changes in Sharpe ratios depending on base currency and destination equity market, in our view they are not large enough to warrant deviating from the baseline approach determined by our analysis of historical relative asset class volatility.
Bottom line: both a historical analysis of relative FX-asset class volatility and forward-looking analysis built on the LTCMAs support our general strategic approach of leaving international equity allocations unhedged, while hedging foreign currency fixed income and low-volatility alternatives.
Sources: (Tables above) Bloomberg Finance L.P., J.P.Morgan Private Bank, J.P.Morgan Asset Management Long Term Capital Market Assumptions. Data as of July 2025.
3. A potential framework for tactically deviating from the strategic approach
Crucially, the findings above rely on the historical safe-haven characteristics of the U.S. dollar (and Japanese yen) persisting. The fact that portfolio volatility declines when international investors leave U.S. dollar equities unhedged is the direct result of an assumed negative correlation between the U.S. dollar and risk assets.
However, negative correlation between U.S. equities and the U.S. dollar does not always persist, as was the case between 1970 and 2005 (Figure 1 and 2). 2025 is proving to be one of those years, with implications for the optimal FX-hedging strategy over the near-term.
Figure 1. Correlation between the U.S. dollar and equities
S&P 500 v.s. U.S. Dollar, 3-year rolling correlation, %
Note: Uses DXY for the U.S. dollar which compares the U.S. dollar to 6 major foreign currencies. Correlation is based on weekly price data. Source: Bloomberg Finance L.P. Data as of June 27, 2025.
Figure 2. U.S. dollar safe-haven characteristics
Cumulative performance of U.S. dollar when S&P 500 is down 1 std, %
Note: Uses DXY for the U.S. dollar which compares the U.S. dollar to 6 major foreign currencies. Weekly price data. Source: Bloomberg Finance L.P. Data as of June 27, 2025.
The charts below (Figure 3 and 4) – while admittedly backward-looking – shows that while USD-based investors are even more incentivized to leave cross-border equity exposure unhedged at present, and the optimal FX-hedge ratio for foreign investors in U.S. equities is on the rise. Indeed, history shows that the optimal FX-hedge for a foreign investor in U.S. dollar assets, while volatile, is materially higher in a period of U.S. dollar weakness than at times of persistent U.S. dollar strength. Some of the quicker-moving institutional funds in Europe are already acting; the Danish pension fund and insurance industry, for example, has increased its U.S. dollar hedge ratio by 12%pts year-to-date, back to near the highest levels seen over the past 10 years (Figure 5).
Figure 3. Foreign investors are incentivized to hedge
Investors optimal hedge ratio for investing in S&P500 to maximize risk/reward, %
Note: Optimal hedge ratio is the one which maximizes Sharpe ratio over the last 3-months. Source: Bloomberg Finance L.P. Data as of July 11, 2025.
Figure 4. U.S. investors are incentivized to be unhedged
Optimal hedge ratio to maximize risk/reward, %
Note: 3-month on weekly data uses average hedge ratio. Source: Bloomberg Finance L.P. Data as of July 11, 2025.
Figure 5. Danish pension funds and insurance companies have increased their FX hedge ratios
Hedge ratio, % of invested assets which are currency hedged
Source: Exante Data, Macrobond, Danmarks Nationalbank. Data as of April 1, 2025.
Bottom line: While our strategic approach to FX-hedging calls for fully hedging fixed income and lower-volatility alternatives and leaving foreign currency equity positions unhedged, the current environment of U.S. dollar weakness argues for considering tactically deviating from the strategic approach in the near-term – particularly for non-USD based investors to increase their hedging ratios on U.S. equities.
To discuss whether a customized, tailored approach to FX-hedging is suitable for your portfolio, contact your J.P. Morgan team.
Appendix: Analysis based on J.P. Morgan’s Long-term Capital Market Assumptions (LTCMAs) with other base currencies.
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Meier, Iwan, 2019, “Currency Hedging of Global Equity Portfolios,” Canadian Derivatives Institute.
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Note: This is the time frame with uniform data across asset classes and currencies.
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We focus here on aggregate bond indices across jurisdictions. These are the fixed income benchmarks our discretionary investment strategies primarily employ. The historical volatility of USD and EUR high yield and long-duration indices are closer to that of the relevant exchange rate, or even higher. As such, the argument for fully FX-hedging designated high yield or long-duration positions is less clear-cut and more situation-dependent, based on this analysis.
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As most alternatives are denominated in USD, we eschew an analysis for USD-based investors.
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For more detail on how return and volatility projections are derived, see the full Long Term Capital Market Assumptions publication here: https://am.jpmorgan.com/gb/en/asset-management/institutional/insights/portfolio-insights/ltcma/?gad_source=1&gclid=CJjvjobq9oYDFctGHQkdoEoKXg&gclsrc=ds
All market and economic data as of July 14, 2025 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
DEFINITIONS
- DXY: The U.S. Dollar Index (DXY) indicates the general initial value of the USD. The index measures this by averaging the exchange rates between the USD and major world currencies.
- MSCI World: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
- S&P 500: Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941–43 base period.
- STOXX Europe 600 Index (SXXP Index): An index tracking 600 publicly traded companies based in one of 18 EU countries. The index includes small cap, medium cap, and large cap companies. The countries represented in the index are Austria, Belgium, Denmark, Finland, France, Germany, Greece, Holland, Iceland, Ireland, Italy, Luxembourg, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom.
- MSCI Japan Index: The MSCI Japan Index is a free-float weighted equity JPY index designed to measure the performance of the large and mid-cap segments of the Japanese market. It was developed with a base value of 100 as of December 31 1969.
- MSCI UK Index: The MSCI United Kingdom Index is a free-float weighted equity index that is designed to measure the performance of the large and mid-cap segments of the UK market. It was developed with a base value of 100 as of December 31, 1969.
- MSCI Switzerland Index: The MSCI Switzerland Index is a free-float weighted equity index that is designed to measure the performance of the large and mid-cap segments of the Swiss market. It was developed with a base value of 100 as of December 31, 1969.
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Investing in assets outside your home market is a vital component of building a diversified multi-asset portfolio. However, your portfolio goals can’t be achieved without properly managing the currency risks associated. In this piece, we outline a strategic approach to FX hedging for the three major asset classes: fixed income, equities, and alternatives.
Samuel Zief
Global Macro Strategist & Head of Global FX Strategy
Yuxuan Tang
Global Market Strategist
Harry Downie
Cross-asset Strategist
Published Aug 8, 2025
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