JULY 2019 European Monthly Research Report: Analysing currency hedging in Euro-denominated funds

We are pleased to present our latest monthly research report for July 2019, quantifying the significant financial benefits that dollar-based investors can lock in through their currency forward hedging, when investing in EUR-denominated real estate investment funds. The precise benefits vary for USD, AUD and CAD-based investors over time. Nevertheless, currency forward pricing has been able to consistently contribute a positive carry on top of EUR-denominated fund returns over the last five years. This should dispel a persistent and common perception that currency hedging increases costs and hurts returns.

  • With non-Euro based investors making up the majority of investment transactions in the Eurozone investment market, the need for currency hedging has increased. Traditionally seen as drag on returns, our analysis shows the opposite.
  • Although most cross-border investors are required to hedge their currency risk when investing in EUR-denominated funds, USD, CAD and AUD-based can avoid costs related to this. In fact, they can lock into positive carry spreads of between 160 and 240bp pa on current pricing of five-year EUR forward contracts.
  • Korean Won based investors are also able to achieve a positive spread of just over 100bp pa, but Japanese Yen based investors on the other hand are seeing some, but mostly negligible, hedging costs. This is due to negative interest rates in Japan, which are very similar to those in the Eurozone. Based on interest rate parity this triggers less favorable forward currency pricing for them.
  • As cross-border investment into the Eurozone real estate markets continues to increase, this positive carry should allow many non-EUR based investors to book better local currency returns on EUR-based funds targeting investments in the region.
GAIN (% PA) ON 5-YEAR EUR-LOCAL CURRENCY FORWARD CONTRACT (CURRENT AND HISTORICAL PRICING)

Sources: Chatham Financial & AEW

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The information and opinions presented in this research piece have been prepared internally and/or obtained from sources which AEW believes to be reliable; however, AEW does not guarantee the accuracy, adequacy, or completeness of such information.

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Hans Vrensen
Head of Research, Europe

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