From Schweser qbank, there is the following statement: when considering whether to proxy hedge, “proxy hedge only makes sense when we have high correlations for the currency movements” and that the reason a manager will use a proxy hedge is the manager may expect one currency to underperform relative to another. If currencies are moving in opposite directions, there may be an opportunity to capture extra returns from those movements.
I don’t understand why this is a reason to proxy hedge. A currency hedge shouldn’t be taking a directional view and looking to capture excess returns. Can someone elaborate on this?
Proxy Hedge essentially hedges through a higly correlated foreign currency instead of the underlying Fx
Let’s assume you are long on an asset valued in Argentinian Pesos (ARS). You want to neutralise the Fx impact but instead of shorting same currency (that would be shorting ARS) you short Mexican pesos (MXN) because :
They are highly correlated with ARS ;
MXN has more liquid market than ARS. (that’s why the proxy hedge)
In this case they say if the two currencies (I assume MXN and ARS move in the opposite direction) there might still be the chance to gain excess return instead of just hedging.