Currency Risk and Equity Allocations by International Mutual Funds

Abstract

We show that international equity mutual funds underweight equity markets with risky currencies and overweight equity markets with less risky ones. This risk-management practice is an important determinant for allocations among foreign equities and can also help explain levels of home bias for individual funds. On average, this leads to a reduction of fund volatility but puts a constraint on stock-picking and performance. Our findings stress the importance of currency risk in explaining equity allocations by professional asset managers around the world.