Hedged funds

aroominyork

In a diversified portfolio, isn’t one valid form of diversification reducing the impact of forex movements on your portfolio?

In some previous threads the question of buying hedged funds has come up and most people have been against it because i) it is gambling on currency markets, ii) exchange rates revert to a mean, and iii) you pay extra.

I find the first point curious. If I want to invest in the American, Japanese or whatever stock market, it seems that not hedging is gambling since returns are affected by the market and also by currency movements, whereas a hedged fund is a more ‘pure’ stock market investment as it solely reflects movement in the market.

Re reverting to mean – yes, I get that, though Sterling will probably rise once (if…) Brexit is sorted out, but I take the point that deciding when to switch from hedged to unhedged is attempting market timing.

dividendhero

"Hedge" does mean to reduce risk by taking an opposite position, but this is not the way hedge funds work. They're name is an oxymoron

aroominyork

dividendhero wrote: »

"Hedge" does mean to reduce risk by taking an opposite position, but this is not the way hedge funds work. They're name is an oxymoron

I am not talking about 'hedge funds' - I am talking about 'hedged funds', ie OEICs/ETFs that neutralise the currency risk. Examples are a hedged S&P500 tracker ETF, or Lindsell Train's hedged version of their Japanese equity fund.

Malthusian

Holding an unhedged global investment gives you a hedge against your own currency falling. As we saw after the Brexit referendum. Sterling fell but global investments rose in Sterling terms, because non-Sterling assets bought more Sterling, so the buying power of your investments remained roughly the same. In contrast to the global buying power of Sterling-denominated cash or wages, which fell.

This only doesn't apply if you are buying stuff that is entirely made within the UK or otherwise priced only in Sterling, and in today's globalised world there is very little of that.

Currency hedging is therefore essentially gambling that Sterling is going to rise, and therefore that you want your currency hedged into Sterling, so that when it does your global investments will still be worth just as much in Sterling. Unless you are living on a remote Scottish island and buy almost nothing except food and tools made on the island and priced in Sterling. Then hedging makes more sense.

A_T

UK Smaller Companies are less subject to the currency effects of a rising pound.

aroominyork

Maybe I’m missing something here, but…

Malthusian wrote: »

Holding an unhedged global investment gives you a hedge against your own currency falling.

Surely it hedges against your currency rising (not falling), as that is when the Sterling value of global assets will fall.

As we saw after the Brexit referendum. Sterling fell but global investments rose in Sterling terms, because non-Sterling assets bought more Sterling, so the buying power of your investments remained roughly the same.

I don’t understand what you mean by the ‘buying power’ of my investments? Do you mean I can sell one global asset and buy another equivalent asset so it’s a zero sum game?

This only doesn't apply if you are buying stuff that is entirely made within the UK or otherwise priced only in Sterling, and in today's globalised world there is very little of that.

But if Sterling rises 10% causing my non-Sterling assets to fall in Sterling terms by 10%, the cost of the stuff I buy to live on is not going to go up by the same 10%, only by a fraction of that. So the hedge still provides some protection.

AnotherJoe

I believe the issue with your question is the inherent assumption that you can usefully hedge and for example provide protection over the pound falling for (or rising) over say the next ten years. I dont see any point in hedging funds unless its for three months or something of that order.

Long term its just a drag on performance. It must be. If for example the pound is going to fall consistently over say the next 10 years, you cannot possibly hedge against that, it woudl be like holding back the tide.

And if the pound just washed backwards and forwards between say 1.2 and 1.6 you'd end up paying a lot of money for nothing since you'd end up roughly where you started at the beginning but paying handsomely over the ten years for that.

EdGasketTheSecond

Hedged funds are useful for someone who wants to invest in foreign shares without gambling on currency exchange rates which may help you and increase your gain or move against you and reduce your gain/make a loss.

If you want you can be in a hedged fund for 10 years and the currency will be hedged for 10 years. I therefore disagree with the previous post that claim it will be like holding the tide back; not at all. The fund will simply keep purchasing forex futures to neutralise forex movements in the fund. There will be some costs involved though compared to an unhedged fund.

Prism

aroominyork wrote: »

But if Sterling rises 10% causing my non-Sterling assets to fall in Sterling terms by 10%, the cost of the stuff I buy to live on is not going to go up by the same 10%, only by a fraction of that. So the hedge still provides some protection.

If Stirling rises 10%, your foreign purchases including petrol, food, tech etc should drop 10%

AnotherJoe

EdGasketTheSecond wrote: »

Hedged funds are useful for someone who wants to invest in foreign shares without gambling on currency exchange rates which may help you and increase your gain or move against you and reduce your gain/make a loss.

If you want you can be in a hedged fund for 10 years and the currency will be hedged for 10 years. I therefore disagree with the previous post that claim it will be like holding the tide back; not at all. The fund will simply keep purchasing forex futures to neutralise forex movements in the fund. There will be some costs involved though compared to an unhedged fund.

And these will be non trivial and over time cost as much as the fall in the currency.

aroominyork

AnotherJoe wrote: »

And these will be non trivial and over time cost as much as the fall in the currency.

Not necessarily. About 20% of my US holdings are in an S&P tracker, the hedged XDPG. Its OCF is 0.09% which is no different from unhedged equivalents. And the reason I started this thread was to decide between the hedged and unhedged version of Lindsell Train Japanese, both with an OCF of 0.79%. Given that the Japanese economy is a little less closely tied to the global economy than the UK, US and Europe, I wonder whether a rising Japanese stock market has any correlation with a strong Yen and vice versa? I will check that later today. Because if that correlation exists, hedging could provide a little downside forex protection in a falling Japanese stock market.

Prism wrote: »

If Stirling rises 10%, your foreign purchases including petrol, food, tech etc should drop 10%

But they don’t, do they? Maybe they fall by a couple of %. Most of the price you pay is for marketing, distribution, overhead, profit etc. after the product enters the UK.


Edit: OK, I’ve compared the Nikkei against the Sterling/Yen forex rate over the last ten years. From 2009 to 2012 the Nikkei drifted down a little and at the same time Yen strengthened by a similar amount. Then to 2015 the Nikkei rose and the Yen weakened, again showing a similar trajectory. For the next year the Nikkei fell and the Yen rose. Then Brexit 2016 happened so Sterling fell/Yen rose. And since late 2016 the Nikkei has risen a little and the Yen weakened similarly. Conclusion: over this time period there was an inverse correlation between the performance of the Nikkei and the strength of the Yen, which means that for currency protection in a falling Japanese stock market an unhedged fund would have been preferable. Am I reading this correctly?