What Is a Natural Hedge?

A natural hedge is a management strategy that seeks to mitigate risk by investing in assets whose performances are inherently negatively 澳洲幸运5官方开奖结果体彩网:correlated. Fo♑r instance, a natural hedge against owning financial stocks is to hold bonds, since interest rate changes tend to influence each in opposite fashion,

A natural hedge can also be implemented when institutions exploit their normal operating procedures. For example, if they incur expenses in the same currency that their revenues are generated they will actually reduce their 澳洲幸运5官方开奖结果体彩网:exchange rate risk exposure, naturally.

Understanding Natural Hedges

A natural hedge entails using asset classes, that have historically exhibited contrasting performance in a given economic climate, to reduce a portfolio's or company's overall risk. The key concept is that by allocating resources to two different asset classes, the risk emanating from one asset should be offset by the return from the other and vice versa.

Essentially, the cash flow from one s෴hould cancel out the cash flow from the other, thus fulfilling the concept of a hedge.

A company with significant sales in one country is𝔉 exposed to currency risk when they want to repatriate that revenue. They can reduce this risk if they can shift operations to where they can incur expenses also in that foreign currency, which would qualify as a natural hedge.

A commonly used example is that of an oil producer with refining operations in the US that is (at least partially) naturally hedged against the cost of crude oil, which is denominated in U.S. dollars. While a company can alter its operational behavior to take advantage of a natural hedge, such hedges are less f😼lexible than financial hedges.

Special Considerations

Unlike other conventional hedging methods, a natural hedge does not require the use of sophisticated financial products such as forwards or 澳洲幸运5官方开奖结果体彩网:derivatives. That said, companies can still use financial instruments such as futures, to supplement their natural hedges.

For example, a 澳洲幸运5官方开奖结果体彩网:commodity company could shift as much of their operations to the country where they plan to sell their product, which is a natural hedge against 澳洲幸运5官方开奖结果体彩网:currency risk, then use futures contracts to lock in the price to sell (revenue) that product at🧸 a later date.

Most hedges (natural or otherwise) are imperfect, and usually do not eliminate risk completely, but, they are still deployed a🗹nd are considered to be successful if they can reduce a vast portion of potential risk.

Other Examples of Natural Hedges

Natural hedges also occur when a business's structure protects it from exchange rate movements. For example, when suppliers, production, and customers are all operating in the same currency, large companies may look to source 澳洲幸运5官方开奖结果体彩网:raw materials, components, and other production inputs in the final consumer's country🌃. The business can then set costs and prices i♋n the same currency.

For 澳洲幸运5官方开奖结果体彩网:mutual fund managers, 澳洲幸运5官方开奖结果体彩网:treasury bonds and 澳洲幸运5官方开奖结果体彩网:treasury notes can be a natural hedge against stock price movements. This is because bonds t🐠end to perform well when stocks are performing poorly and vice versa.

Bonds are considered to be "risk-off" or safety assets while stocks are considered to be 'risk-on' or aggressive assets. This is a relationship that has been historically valid most of the time, but not always. In the years after the 2008 financial crisis, this negative correlation between bonds and stocks decoupled as both moved in tandem (e.g., strong 澳洲幸运5官方开奖结果体彩网:bull markets), so this natural𓆏 hedge would not h⛦ave been successful.

澳洲幸运5官方开奖结果体彩网:Pairs trading is another type of natural hedge. This involves buying long and 澳洲幸运5官方开奖结果体彩网:short positions in highly 澳洲幸运5官方开奖结果体彩网:correlated stocks because the performanc﷽e of one will offset the performance of the other.