Lack of Currency (GBP) Hedged Investment Funds

[Deleted User]

Why are most popular funds such as LS80 or Consensus 85 not currency hedged to £?

There seems to be a big lack of £ hedged multi index funds in my opinion, I would like to invest in some to avoid the currency exchange risk.

Malthusian

Because hedging a global equities fund doesn't avoid currency risk, it adds it.

If you hold global equities and the pound rises then your fund falls in Sterling terms, but your Sterling buys more of everything made outside the UK, i.e. almost everything. Whether Sterling rises or falls your buying power remains roughly the same.

If you hold hedged global equities and Sterling rises, the £ value stays the same and the buying power of your hedged global equity fund rises. If you hold hedged global equities and Sterling falls, your buying power falls. When you chose to hedge the buying power of your fund became dependent on fluctuations in the currency. That means you've added currency risk. Risk = variability of outcome.

Not many people want a side of forex gambling with their diversified global equities so there is little demand for a currency hedged Vanguard LifeStrategy. Most people investing in global equities are doing so partly to avoid their fortunes being dependent on the fortunes of their local currency.

pip895

I have used a hedged ETF :- iShares III plc (IWDG) Core MSCI World UCITS ETF GBP DIS H GBX. I thought sterling was undervalued when I went for it. It is more undervalued now lol - but you never know...

bowlhead99

As said above, having a diversified set of assets is all about being diversified. In the long term you are exposed to all sorts of costs and expenses driven by pricing determined on a global scale in increasingly borderless markets.

Whether or not a currency unit called 'the pound' exists, it makes sense to own broadly diversified assets. They might be equity shares in Microsoft or Tencent or Nintendo or Samsung or Tesco, or loans to Nestle or the US government, or shares in a company that owns a gold mine in the Congo, or a casino in Macau, an oilfield in Saudi, or blocks of gold that have already been mined, etc etc.

By buying your global holdings you will get all of these - and it's true that the underlying business assets and liabilities to which you're exposed, and the future income streams from the businesses, will be in a mix of USD, HKD, RMB, Yen, Euro, Won, Franc etc. As a part owner of Microsoft or Disney or Shell, every 0.0000000x% of the revenue they earn from MS office or cloud storage or Star Wars merchandise or crude oil will beneficially belong to you, and it's in a mix of currencies.

We use 'how many pounds are in my bank account' as a way of keeping score, but there is no point doing a victory dance if FX rates change from time to time so that the dollars or euros generated by your investee companies are worth more pounds because it means it costs you more pounds to buy your cloud storage or Star Wars figurines or petrol or bananas.

To be properly diversified means having a whole load of international assets that are worth something on a world stage, even if the buying power of a pound on the world stage diminishes or the pound entirely ceases to exist.

If you instead say, "I'd like my pension to be worth 10% more pounds if Nintendo earn 10% more yen, regardless of what those yen are actually worth in pounds", you are asking for trouble. To maintain that illusion for yourself will have a cost in terms of hedging (because it is not cheap to implement), so practically you would only have 9.x% extra pounds instead of 10% extra. But more importantly you will find yourself a relative loser if pounds devalue a lot and the price of Nintendos and Toyotas increase to cost 'only' 10% more yen but 60% more pounds. You would find yourself in a position where your 'unhedged' neighbours and other worldwide citizens with whom you are competing to buy the Nintendos and Toyota's can still afford them, and you can't.

As it happens, I do used some currency hedged investments from time to time, and at the moment have a few thousand in a GBP hedged S&P tracker. But short term tactical personal decisions should not really get in the way of a sensible long term strategy. There is a tendency for 'newb investors' (nothing personal ) to jump on all sorts of things that sound like clever ideas and before you know it they have a whole bag of clever ideas and tactical overlays based on personal hunches, and have only left 10% of their assets to allocate against the sensible long term core strategy. It should be the other way around.

[Deleted User]

If the pound rises though, do the prices of foreign products we buy REALLY go down in the shops though? I'm not convinced they do.

eskbanker

newbinvestor wrote: »

If the pound rises though, do the prices of foreign products we buy REALLY go down in the shops though? I'm not convinced they do.

Depends on the products and the shops!

Clearly a strengthening pound should reduce the cost of foreign products to the retailer, assuming the benefits aren't absorbed further back in the supply chain of course, but even then that doesn't necessarily mean that retailers will pass this on to customers....

[Deleted User]

I would much prefer my Japanese portfolio to be worth £100 rather than be worth £90 with a 10% stronger £ against the yen.

eskbanker

newbinvestor wrote: »

I would much prefer my Japanese portfolio to be worth £100 rather than be worth £90 with a 10% stronger £ against the yen.

Well obviously, but how would you feel about missing out on £110 from a 10% weakening of £ against the yen?

[Deleted User]

eskbanker wrote: »

Well obviously, but how would you feel about missing out on £110 from a 10% weakening of £ against the yen?

It's a good point but I would prefer to be hedged even if I missed out on such events.

bowlhead99

newbinvestor wrote: »

If the pound rises though, do the prices of foreign products we buy REALLY go down in the shops though? I'm not convinced they do.

Some are more sensitive than others, of course, and it can take time for retailers or manufacturers to react. And sometimes such changes get masked or offset by changes in other commodity prices (eg your currency 'should' buy more wheat or oil or iron because it's become relatively stronger than other currencies, but wheat or iron or oil is going through a price spike so actually you can't buy any more of it for your money - and what you don't notice is that you can temporarily buy relatively more of it than people in other countries). We are not always good at focusing on the big picture.

But yes it was generally cheaper importing 'stuff' from the USA twelve years ago at $2.10 for every pound than eleven years ago when the pound only got $1.60, and cheaper four years ago at $1.50 than three years ago at $1.25. You might not notice the 'cheapness' at the time the pounds are relatively strong, and only see it when they lose that strength instead.

Perhaps if you are risk averse the thing to focus on is not whether or not things really do get cheaper when pound is stronger, but instead the opposite, that they get more expensive. The risk of 'goods and services with a foreign cost component getting more expensive in pounds when pounds lose their buying power'. However, trying to make a long term asset allocation to hedge out that risk by paying for artificial maintenance of your currency strength, is implicitly going to cost you some money, and it doesn't make a lot of sense to say you are going to use a market index-based product like a 'lifestrategy' or similar fund for a low cost asset allocation and then add a costly artificial overlay as an imperfect hedge because you don't really like being exposed to a global set of assets.

If it is really the case that you are concerned about risk of 'goods and services with a foreign cost component getting more expensive in pounds when pounds lose their buying power' it seems that buying a load of foreign assets and not hedging them, is fine, because that way you will already own lots of underlying USD and EUR and RMB and yen assets and income streams, and you haven't lost any long term buying power after all when you compare yourself to your global peers who also own assets in USD and EUR and etc etc. If you instead try to hedge out any downside risks, you hedge out the upside gains that you eventually need to keep parity with international citizens.

The idea that you'll have fewer pounds on your scoresheet when the pound strengthens and a share of VLS80 is officially worth fewer pounds, doesn't *look* good on your account balance but if you still own the same 0.0000000x% of Microsoft and of a Congolese gold mine, Mexican car plant and Tokyo skyscraper, you shouldn't be too hard on yourself. Preserving wealth is not all about preserving pounds. Pounds are something we use to keep score relative to our workmates but it's the stuff underneath that counts.

Another way of saying the same thing is that "making sure I have just as many pounds as my idiot neighbour who refused to take any currency exposure on his retirement fund" is not a great goal. When you go to buy a loaf of bread or car or washing machine or download a movie in the future, your capital is not just competing with your idiot neighbour but with all the owners of capital around the world, who set the prices to which you are exposed.