Currency Exposure and Hedging Strategies for Limited Partners Investing in Private Equity

Abstract: This paper sets out to examine how limited partners investing in private equity should define currency exposure and whether they should hedge it or not. To our knowledge, no previous research has investigated this field. The subject is important since foreign investments in private equity are increasing. Using investment data from a specific limited partner and simulated foreign exchange rates, we find that limited partners should define currency exposure as the currency that denotes the portfolio company of the private equity fund, and hedge accordingly. This strategy yields similar mean returns but reduces the riskiness of those returns, and thus yields the highest risk-return trade-off, compared to other hedging strategies. An implication of this result is that many limited partners investing in private equity mishedge their currency exposure. Furthermore, we find that limited partners investing in private equity should diversify their assets under management by investing in private equity funds exposed to several currencies, through the portfolio companies.