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Journal of
Property
Finance
The Use of Exchange-rate Hedging Techniques by UK Property Companies
Alex J.D. Dawson
St Quintin, and
William H. Rodney
City University Business School, London, UK
Commercial property for many years has assumed an important position in thedomestic portfolios of portfolio investors. Several studies have concluded thatinvestment portfolios should hold between 5 per cent and 15 per cent of theirportfolios in their domestic property market, for diversification, inflationhedging, as well as for superior investment performance[1,2].

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The main features of modern portfolio theory are that investors seek to
maximize their utility of wealth while reducing their exposure to risk. Byconstructing diversified portfolios of assets that are not perfectly positivelycorrelated, specific risk associated with a single asset may be diversified away.Elements of market risk will remain, as assets within a class tend to show somepositive correlation. By diversifying internationally, the market risk of aportfolio may be reduced still further, reducing risk and increasing return as a
result of extending the investment boundaries to national markets that have lowcorrelations, thereby reducing market risk to low or even zero levels[3,4].Fluctuations in price are one of many risks of a foreign investment, furthercompounded by fluctuations in exchange rates which may exacerbate any fallin property values once returns are converted to the home currency. Since thecollapse of globally fixed exchange rate systems (The Bretton WoodsAgreement) in 1971, international financial instability has affected exchangerates and increased their volatility. An international investor who does nothedge his investment is therefore speculating on exchange-rate movements aswell as his foreign holdings. Exchange-rate movements do have their rewardsfrom speculation, but may also show similar losses. In any case, it introduces adifferent type of risk which has to be accounted for.
Although the world financial markets are becoming more integrated, there
remain variations in financial stability and timing of the economic cycles ofdifferent nations. A UK-based investor in foreign property markets mustconvert holdings back to sterling for incorporation into his financial statements.
By hedging currency risks, exchange-rate movement can be separated and
eliminated from the risk-return profile of the underlying investment, givingreturns to the investor from the actual property investment only.
Journal of Property Finance,Vol. 5 No. 4, 1994, pp. 56-67
MCB University Press, 0958-868XExchange-rate
Hedging
Techniques
57
There are few UK property companies which have the size of funds to investon an international basis and are able to diversify internationally by type,location and size to a similar extent to their involvement in the UK.Somecompanies maintain a policy of not diversifying overseas at all. The mostcommon constraints to overseas investors are the availability of adequateinformation. Details of aproperty opportunity overseas in competition with the
local investors and the ability actively to manage investments mayreduce theattraction of an overseas investment. Property is by its very nature aninvestment asset which requires active hands-on management in order to
maximize performance, a constraint which deters many property investor