Sterling Fall

masonic

AnotherJoe wrote: »

Which is why i think hedging is more than pointless.

Taking that example as correct (i havent read the article) the hedging has caused underperformance when the currency weakened and therefore will cause over performance when it strengthens. The two cancelling out.

And there's a cost to the hedging which overall lowers performance whatever happens and since in the long term you cannot evade the long term change in the £/$ rate all you are doing is paying to minimise volatilty, not the end result of the £/$ change.

Under normal circumstances, and over the long term I would tend to agree with you. But when you've inadvertently made substantial gains from an asset allocation that gives you more exposure to both EUR and USD than your home currency, then it could be time to take the Harry Markowitz 50/50 approach and apply it to this situation. If the pound continues to weaken, I'll still get a decent amount of 'compensation' through my unhedged international equities holdings, but if mean reversion happens I'll hold on to some of my previous gains. The cost of doing this used to be significantly higher than it is now, and would have put me off, but this appears no longer to be the case.

Of course, an alternative to this would be to overweight my UK equities holdings, but I'd consider that riskier.

AnotherJoe

masonic wrote: »

Under normal circumstances, and over the long term I would tend to agree with you. But when you've inadvertently made substantial gains from an asset allocation that gives you more exposure to both EUR and USD than your home currency, then it could be time to take the Harry Markowitz 50/50 approach and apply it to this situation. If the pound continues to weaken, I'll still get a decent amount of 'compensation' through my unhedged international equities holdings, but if mean reversion happens I'll hold on to some of my previous gains. The cost of doing this used to be significantly higher than it is now, and would have put me off, but this appears no longer to be the case.

Of course, an alternative to this would be to overweight my UK equities holdings, but I'd consider that riskier.

What would you define though, as a "UK" holding? Unless its a UK smaller companies fund, (which has its own set of risks, more so now than probably at any previous time since 1939), or you are holding individual company shares picked for the UK-centricity, it's very hard to invest in "the UK" and you are taking currency risk even if its not explicit. If for example the "perfect" Brexit solution* suddenly comes from left field and the Pound rises as a result, expect your "UK" shares to drop.




* there isn't a flying pig emoticon but imagine one here

masonic

AnotherJoe wrote: »

What would you define though, as a "UK" holding? Unless its a UK smaller companies fund, (which has its own set of risks, more so now than probably at any previous time since 1939), or you are holding individual company shares picked for the UK-centricity, it's very hard to invest in "the UK" and you are taking currency risk even if its not explicit. If for example the "perfect" Brexit solution* suddenly comes from left field and the Pound rises as a result, expect your "UK" shares to drop.

* there isn't a flying pig emoticon but imagine one here

I wouldn't say I held any substantial UK holdings. I hold two funds that invest primarily in UK listed companies: FGT and Marlborough Micro Cap Growth. The former holds Diageo, Unilever and Relx as its largest holdings, so takes a substantially global stance, whereas the latter is more UK-centric but small and risky as you correctly point out. These two holdings between them make up about 7% of my portfolio. I also get a little bit of UK exposure from JEO, which is 20-25% invested in UK stocks, but very little of that is real UK exposure (that makes up about 5% of my portfolio, the rest of my Eurozone exposure is passive and ex-UK).

So this is why I'm starting to feel the need for some hedging against the pound rising, either through the highly unlikely result of a "perfect" Brexit solution, the slightly more likely result of markets realising things aren't quite so bad, or the even more likely result of the US catching a cold and the rest of the world sneezing a little less fiercely.

AnotherJoe

masonic wrote: »

So this is why I'm starting to feel the need for some hedging against the pound rising, either through the highly unlikely result of a "perfect" Brexit solution, the slightly more likely result of markets realising things aren't quite so bad, or the even more likely result of the US catching a cold and the rest of the world sneezing a little less fiercely.

But you cant really hedge against the pound rising or falling over say the next 20 years assuming thats your sort of investment timescale. All you'll do is pay money for an illusion. If the Pound is say 1:1 or 2:1 in 20 years time, you cant hedge against that.

My view is, if Brexit is a fantastic success and the economy in the UK is booming and the Pound very strong, well my hedge will then be I'm living in a prosperous UK. Or if its the other way round, weak pound terrible economy, my hedge is, my investments have risen even more in value (or fallen less).
And if its roughly the same as is now or its in within the historical bounds of the last 20 years, I havent wasted money trying to hold back the tide.

masonic

AnotherJoe wrote: »

But you cant really hedge against the pound rising or falling over say the next 20 years assuming thats your sort of investment timescale. All you'll do is pay money for an illusion. If the Pound is say 1:1 or 2:1 in 20 years time, you cant hedge against that.

Let's remove stockmarket gyrations in local currency from the equation to examine this further. I don't think I've seen you dispute the premise that a GBP-hedged fund can neutralise price movements originating from exchange rate movements.

So if the pound is say 1:1 or 2:1 in 3 years or 20 years time, an unhedged fund will be 28% better off or 56% worse off respectively than the hedged variant. After adding in the difference in OCF of 0.03% per year, relative performance would be either:

1:1, 3 years: 29%28% more unhedged
1:1 20 years: 34%29% more unhedged
2:1 3 years: 55%56% more hedged
2:1 20 years: 50%55% more hedged

Edit: figures above corrected as I used an OCF difference of 0.3% instead of 0.03%!

Realistically I don't intend to hedge over 20 years, and I don't intend to hedge my exposure to international equities and the global economy to a very large degree. But I am, as you point out, very underweight in exposure to the real UK economy, and my spending into the real UK economy is somewhat higher than my investment exposure.

My view is, if Brexit is a fantastic success and the economy in the UK is booming and the Pound very strong, well my hedge will then be I'm living in a prosperous UK. Or if its the other way round, weak pound terrible economy, my hedge is, my investments have risen even more in value (or fallen less).
And if its roughly the same as is now or its in within the historical bounds of the last 20 years, I havent wasted money trying to hold back the tide.

The main benefits of the above "prosperous UK" scenario will be delivered to those with plenty of human capital to spend acquiring financial capital. For those who have built up sums of financial capital in excess of their remaining earning potential, the situation is rather different.

To be clear I think the prosperous UK scenario is unlikely, but I'm willing to sacrifice some of the "weak pound terrible economy" gains to insure against it. But I'm happy to hear arguments as to why that won't work, starting of course with why the figures I've postulated above aren't realistic outcomes for a GBP-hedged fund.

AnotherJoe

masonic wrote: »

Let's remove stockmarket gyrations in local currency from the equation to examine this further. I don't think I've seen you dispute the premise that a GBP-hedged fund can neutralise price movements originating from exchange rate movements.

.

maybe thats why our disagreement.



My position is that its realistically impossible to hedge against large movements over long durations because the cost would be huge.


So yes, following on from that starting point, which you may or may not agree with, thats why i think the rest of your suppositions fail (and why i didnt go into the exact numbers).


I'm working on the basis that if someone is selling me a promise that with the pound at 1.3 today I can still get 1.3 in 20 years time, theres a massive risk and cost to that, plus a profit, and I'll be paying for all that.

Maybe an analogy would be house insurance, except that with house insurance, only one in 1000(say) houses burn down so you only have to pay 1/1000th of the cost of a new house for your insurance, plus profit margin. If everyones house burnt down, which is what happens with currency movements, you couldn't afford afford insurance.

masonic

AnotherJoe wrote: »

I'm working on the basis that if someone is selling me a promise that with the pound at 1.3 today I can still get 1.3 in 20 years time, theres a massive risk and cost to that, plus a profit, and I'll be paying for all that.

I've already pointed out I don't intend to hedge for 20 years and have given the more realistic window of about 3 years as an alternative. Over 20 years, a difference of 1.3 to 2 is a only 2% annualised and hardly worth it. I agree with you on that point. Over 3 years it is 15% annualised, which is a little more difficult to swallow. Conversely the drop of 1.3 to 1, over 3 years is about 9% annualised (and much less over 20 years).

I've used the same 2:1 and 1:1 figures you've proposed, but in reality other upper and lower cases could have been used.

There is clearly a cost that needs to be paid for the derivative. This cost will be present and likely the same whether the exchange rate moves in your favour or against you. We have data for when the exchange rate moves against you as judged from the 3- and 5-year performance figures of the funds highlighted in the earlier FT article, vs the change in exchange rate over the same period, and it does not appear from that data that the price paid is significant. I acknowledge we don't have data for when the exchange rate moves in the other direction yet.

Maybe an analogy would be house insurance, except that with house insurance, only one in 1000(say) houses burn down so you only have to pay 1/1000th of the cost of a new house for your insurance, plus profit margin. If everyones house burnt down, which is what happens with currency movements, you couldn't afford afford insurance.

That's not a reasonable analogy because what's being entered into is a derivative and the entity on the other end of that arrangement stands to gain when you lose and vice versa. In house insurance, both sides of the arrangement share the loss and nobody gains when a house burns down (well maybe a construction company who is paid to restore it).

TBC15

Rookie13 wrote: »

So the message is get stuck in , roll with the punches and look to the longer term.

+1 get on with it.

Alexland

I don't think anyone here is suggesting that currency hedging is normally required so you should incur the costs over an investment lifetime. A few of us are just thinking that some hedging might be useful to manage risk in periods such as now where our currency is materially impacted by uncertainty or as you get closer to withdrawal to increase certainty of outcome.

Sure it's not as adventurous as running naked into a lion cage but not all of us want to do that.

Alex

londoninvestor

AnotherJoe wrote: »

I'm working on the basis that if someone is selling me a promise that with the pound at 1.3 today I can still get 1.3 in 20 years time, theres a massive risk and cost to that, plus a profit, and I'll be paying for all that.

It's really a question of transaction costs, rather than risk.

The 20y forward rate you can lock in now isn't exactly 1.3: it's the spot rate (1.3ish) multiplied by a factor representing the difference in interest rates. Right now, the spot rate is about 1.2820, and the 20y forward trades about 3850 points above that, i.e. the 20y forward rate would be 1.6670.

A counterparty who trades with you at that rate will apply some markup (i.e. transaction cost), but can offer you the rate risklessly, because there's an arbitrage. Selling you GBP against USD in 20 years' time is equivalent to borrowing USD to buy GBP now, then effectively saving that GBP for 20 years at a fixed rate, by buying a GBP bond. (In practice this might be done using swaps, but the argument that gets you to this as the arbitrage-free price still holds.)

So the forward rate - at least for a liquid currency pair without capital controls - keeps tightly to the rate determined by the spot rate and the interest rate differential.