Is hedging USD still worth it? A hard look at the costs for Swiss investors going into 2025

Summary: The cost of hedging USD is at all-time highs. Many Swiss investors could reduce their hedge ratios and assume more currency risk or cap their exposures using options.

• Many Swiss institutional investors hedge a high percentage of their foreign currencies based on the rationale that the benefits of reducing the risk contribution from their currency exposure outweighs any concerns about costs or missed opportunities.
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• However, the cost of hedging US Dollars has reached extreme levels for Swiss investors, at over 4% per year at current conditions. This is because of the interest-rate differential between the two currencies, as well as the cross-currency basis which adds an additional cost [more on this in an upcoming note].
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• In the past, when investors or their advisors have analysed the impact of currencies on their portfolio, it was hard to escape the conclusion that it is better to hedge as much of the currency exposure as possible since it represents an additive risk with zero expected return. But what if the expected return from not hedging is not zero but actually +4% as is now the case?

• Hedging the US dollar has actually been a significant net cost for Swiss investors for over a decade, unless they were very clever or lucky with their timing. Indeed, over the last ten years Swiss investors who have hedged USD have underperformed unhedged investors by around 20%. This is because the USD/CHF spot rate is back more or less exactly where it started from and because hedging has cost about 2% per year on average.
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• Currency markets have experienced relatively little volatility in this period, but nothing guarantees that we will not again see the sort of movements that old-timers will remember from the 1980s and 1990s when the dollar periodically doubled or halved in value. Recent geopolitical developments make this a lot more plausible.
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• Finally, it is worth keeping in mind that hedging policies were often established (a) during a period when investors' excess reserves were low or non-existent and (b) using historical data that was dominated by a weak dollar environment (2001 to 2011). Now many investors and especially Swiss pension funds have much higher excess reserves and can afford to take on more risk.
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• In conclusion, Swiss institutions should consider hedging less USD than in the last few years. They could also consider capping their exposure in case of a negative scenario by using options. Current implied volatilities are not particularly high and there is not a persistent downside skew in favour of USD puts, so options are relatively affordable.