A bank decides to use $100 million of its capital to launch an investment strategy (seed money). The portfolio which is launched is made of global equities (say ~ 500 equities of different markets).

The bank does not want to be exposed to PnL variations in the portfolio, the intent is only to build a track record for the portfolio. How would you hedge this portfolio?

Do you have to take Beta into account when calculating the hedge ratio?

Or do you simply short futures for the same amount of the long equity positions in each market and roll the futures?

  • $\begingroup$ Since it’s a global equity book, are you hedging the FX exposures, or not? If no, then you might have to hedge each country (or region in case of Euro denominated stocks) by an index futures traded in similar FX as it can minimize risk to FX movements. Also, answer will be different depending upon if you are using TRS (Total Return Swaps) used commonly by quant funds vs direct cash exposures; in the first case you are only exposed to FX moves in PNL, and in the second case you are exposed to FX moves on full investment + PNL. $\endgroup$ – uday Jun 6 '19 at 18:07
  • $\begingroup$ I am thinking of hedging exposure directly with the future in the currency of the long equities. So if 20% of the portfolio is in SPX, hedge 20% using spx futures (in USD). Then if 20% are in UKX, hedge 20% with UKX futures (GBP), etc .. I am trying to find out how to calculate how many futures I need. $\endgroup$ – tweedi Jun 6 '19 at 18:18
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    $\begingroup$ @tweedi, beta * (Amount in Portfolio)/(Single hedging contract value) $\endgroup$ – Vitomir Jun 7 '19 at 9:32

I prefer: corr * (SDstk/SDfut) because it work well in real life. If corr and SDs are all close to one, then you have an optimal instrument with which to hedge such that the notional values of hedge should end up close to equity dollar value.

  • $\begingroup$ What you wrote is just the formula for Beta. $\endgroup$ – noob2 Sep 5 '19 at 15:53

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