Simulating FX hedging strategies and their impact on capital and dividends

With-Profits Portfolio Optimization at a Time Of Heightened Uncertainty III: simulating FX hedging looks at FX impact across several dimensions. More specifically, what is the impact of reducing the FX hedge ratio on capital and dividends?

Frido Rolloos from Ortec Finance just released part III of the series of studies into With-Profits Portfolio at a Time Of Uncertainty. Earlier Ortec Finance published With-Profits Portfolio Optimization at a Time of Uncertainty I and II. The first with-profits funds article analyzed simulation results of a fixed SAA and dissected the risk and return drivers of with-profit funds within a static SAA policy. The second paper focused on the costs and benefits of including equity options of various strikes to mitigate drawdowns. In both previous articles, holdings in foreign assets were 100% hedged and a natural question is to ask what the impact is of reducing the FX hedge ratio.

In this new 10 page paper With-Profits Portfolio Optimization at a Time Of Uncertainty III, the authors conclude the following: “It is clear that the impact of FX hedging on the balance sheet is different, but no less important than equity hedging in regard to with-profits funds. Although FX hedging does not impact returns as much as equity hedging, for the particular set of scenarios considered it is of importance for the Solvency capital ratios. Solvency capital ratios directly determine whether capital injections are required. A platform which can realistically project the balance sheet and manage complex products such as participating funds, is thus an indispensable tool for insurance companies.”