Investments, tenth edition

Rank Developed Emerging 

Rank Legend

3

5

 The decline of the U.S dollar has so far been sporadically interrupted by international crises. A regular feature of 

those crises has been a flight to the safety of dollar instruments. 

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  C H A P T E R  

2 5

 International 

Diversification 

903

 Figure 25.6 

Information ratios of developed and emerging markets against U.S. dollar-denominated 

returns, 2002–2011  

–0.2

–0.1

0.0

0.1

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0

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Information Ratio

Rank

Markets are sorted by information ratio from low to high

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24

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1

Developed + World

Emerging

  1 

Ireland 

Taiwan 

  2 

Greece 

Jordan 

  3 

Finland 

Argentina 

  4 

Italy 

Hungary 

  5 

Belgium 

Turkey 

  6 

Japan 

Poland 

  7 

Portugal 

Russia 

  8 

France 

Sri Lanka 

  9 

Netherlands  Philippines

10 U.K. 

India

11 Germany  Korea

12 Israel 

China

13 Austria 

  Pakistan

14 Spain 

Morocco

15 Hong 

Kong 

Egypt

16 Switzerland 

Malaysia

17 Sweden  Brazil

18 

New Zealand  South Africa

19 Singapore Chile

20 Norway  Thailand

21 Denmark  Mexico

22 Canada 

Peru

23 Australia  Czech 

Republic

24  

Indonesia

25  

Colombia

Rank Developed Emerging 

Rank Legend

we  compare emerging and developed markets using returns in local currencies. Recall that 

U.S. investors can achieve such returns by hedging the currencies of the country portfolios 

in which they invest.   

  Is Exchange Rate Risk Important in International Portfolios? 

  Table  25.3  revealed that changes in exchange rates vary widely across country pairs. 

In  Figures  25.7  to 25.10 we compare results for SD, beta coefficients, average excess 

return, and information ratios for both developed and emerging markets using dollar and 

 local-currency returns.  Figures  25.7  and  25.8  look at the issue of risk. Both measures 

show that returns in local currency are convincingly less risky than dollar-denominated 

returns. The difference (at least over the recent 10 years) is greater when comparing 

beta. Remember, however, that this result applies only to adding one country to the U.S. 

portfolio; relative contributions to risk could change if one were to consider broader 

diversification.   

 Hedging currency risk when investing internationally is often undertaken to reduce 

overall portfolio risk. However, the decision of whether to hedge foreign currencies in 

an internationally diversified portfolio can also be made as part of active management. If 

a portfolio manager believes the U.S. dollar is overvalued against a given currency, then 

hedging the exposure to that currency would, if correct, enhance the portfolio return in U.S. 

dollars. The potential gain from this decision depends on the weight of that currency in the 

overall portfolio. Such a decision applied to investments in only one country would have a 

small effect on overall risk. But what if the manager estimates that the dollar is generally 

overvalued against most or all currencies? In this case, hedging the entire exposure would 

constitute a bet with significant effect on total risk. At the same time, if the decision is 

correct, such a large position can provide handsome gains. 

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904

P A R T   V I I

  Applied Portfolio Management

 Figure 25.8 

Market beta against U.S. using dollar-denominated and local-currency excess returns, 2002–2011  

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48

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31323334

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0

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Beta of Dollar-Denominated and

 Local-Currency Excess Returns

Rank

Betas are ranked from low to high

Beta for Local Currency

Beta for U.S. $