GLOBAL - Currency strength is not an indicator for long-term equity returns, and equity markets experiencing currency weakness are more likely to outperform, a study has shown.
The ABN AMRO / London Business School study, which looked at data since 1900 for a sample of 53 countries, rejected the paradigm that equity markets supported by strong currencies provide superior returns compared to equities in weak-currency markets.
Professors Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School, said: “Our preliminary long-term evidence shows that over the long haul, equity returns have not been bolstered by currency strength. Historically, avoiding weak currencies might have been justifiable to control risk, but not to enhance performance.”
The study also showed that while currency fluctuations can impact short-run equity performance, excahnge rate movements have mattered much less to long-term investors because, in the long term, parity changes have largely tracked relative inflation rates.
“Over more than a century, real exchange rates, after adjusting for differences in inflation rates, have a changed at most by a mere fraction of 1% a year,” read a comment on the study in the ABN AMRO Global Investment Returns Yearbook for 2006.
The yearbook’s study also commented on the impact of currency volatility on the total risk of investing in overseas equities, and the benefits of hedging.
“A key strategic issue for global investors is whether to hedge their foreign-exchange exposure. Our analysis shows that while hedging reduces risk, the gains from risk reduction have declined over time and are now modest compared with the gains available from diversifying equity portfolios internationally,” said Professors Dimson, Marsh and Staunton.
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