Home bias and currency risk

ivormonee

There seem to be more options for hedging back to GBP with ETFs compared with funds where there are less options. And it seems perfectly valid to use an element of such hedging where there are significant short to medium term fluctuations in currency movements. Post EU referendum was a good example. I can understand your concern with GBP during the "brexit" process but a lot of the potential volatilty as a result of this may have been watered down as we now have a withdrawal agreement which is virtually certain to be approved with a subsequent commencement of the transition phase from no later than Jan 31st 2020. The spectre of no agreement has been lifted which in turn has allowed sterling to find a fairly stable range of movement in relation to other currencies. In other words, the politics of brexit are now priced in to the pound's movements. Some hedging will of course continue to reduce volatility nevertheless and provide a cushion for unforeseen outlier events.

aroominyork

bowlhead99 wrote: »

It can be seen by comparison with the 'real' underlying index that the returns are compromised when hedging. For example the unhedged benchmark S&P500 index gave a 1 year return to end of November of 15.41%. The hedged version GSPX gave only 13.15%, which is 2% worse even after adjusting for OCF, so in that case you might have been better to take the US result and the small FX translation loss. The rates only moved from $1.28 to $1.29 during the period, which is less of a drag than the implicit cost of hedging. Really, hedged products are acknowledged as being more expensive but provide some protection in case of a much bigger movement than we observed over the year to November.

bowlhead99 wrote: »

Long story short, comparing the hedged results to an fx-adjusted raw result will help you see the overall effectiveness of the hedge after the fact - though it will be a mixture of 'cost' and 'effectiveness'. You generally need to accept a dull nagging pain of cost, to avoid the short sharp shock of an extreme movement.

This is a real eye opener. I assumed the only cost of a hedged fund was the increased OCF and that by owning XDPG with 0.09% OCF I was guarding a small amount of my equities against currency movements at minimal if any cost. Now I learn there are also costs hidden within the process which can very materially accumulate over the years. The GSPX example is interesting, but it’s beyond the wit of this poster to run a sample on a global (ex-EM) IWDG. So before I reassess the idea of buying IWDG could you guide me (which of course is a polite way of asking if you would run the numbers) in how to do it?

bowlhead99

aroominyork wrote: »

The GSPX example is interesting, but it’s beyond the wit of this poster to run a sample on a global (ex-EM) IWDG. So before I reassess the idea of buying IWDG could you guide me (which of course is a polite way of asking if you would run the numbers) in how to do it?

1) On the iShares website you can see what the return was in dollars for the unhedged version of their Core MSCI World UCITS ETF (SWDA) or for the underlying index measured in dollars (MSCI World) which will be similar to each other (minor differences being costs and tracking error).
https://www.ishares.com/uk/individual/en/products/251882/ishares-msci-world-ucits-etf-acc-fund

Calendar year 2016: 7.5%; Calendar year 2017: 22.4%. Calendar year 2018: -8.7%

2) All sorts of websites (trustnet, morningstar, investment platforms) will let you see what a the return was in pounds for an investor who held MSCI World or that SWDA product.
https://www.morningstar.co.uk/uk/etf/snapshot/snapshot.aspx?id=0P0000LZZD

Calendar year 2016: 29.6%; Calendar year 2017: 11.8%. Calendar year 2018: -3.8%

3) Back on the iShares website again, you can see what the return was in pounds for an investor who held their MSCI World GBP Hedged UCITS ETF (IGWD).
https://www.ishares.com/uk/individual/en/products/251892/

Calendar year 2016: 8.1%; Calendar year 2017: 17.3%; Calendar year 2018: -8.7%

So what does that tell you?

In 2016 the hedged product IGWD delivered 8.1%. The hedge was not perfect but they succeeded in giving you a return much closer to the underlying dollar results (7.5%) than to the dollar translated results which would have given a GBP investor in the underlying index a return of 29.6%. You can see that the large gain to a GBP unhedged investor was quite effectively extinguished by choosing to use the hedged product.

In 2017, IGWD delivered 17.3%. Again this is closer to the underlying dollar-measured returns than to the lower returns experienced by a GBP investor investing unhedged into the international index product while sterling strengthened.

In 2018, IGWD delivered -8.7%, same as the underlying dollar index, while GBP unhedged investors only lost less than half that amount because sterling weakened by 5 percent or so.

As an aside, IWDG the newer 'Core' product which wasn't around in 2016/17, gave a return of -8.3% in 2018. A better result than IGWD and the underlying dollar index's -8.7%; likely evidence that the hedge on both products was imperfect but IWDG had lower OCF, allowing it to get a 'better' result than IWDG. Lower fees are good of course, but if it does better than the underlying dollar index it shows the hedging is not bang on, and you might be disappointed if that was to your detriment rather than to your favour.

You can read into it what you like. I don't have much appetite to do any in depth analysis, as it's not a product I'm looking to buy...

aroominyork

Many thanks, bowlhead. What interests me is the difference between 1) and 3), SWDA in USD and IGWD. What causes an imperfect hedge, such as the quite significant one in 2017? Also, if the hedge is perfect what % of additional cost p.a. would you expect to see as the hidden cost discussed in our earlier posts?

bowlhead99

aroominyork wrote: »

What causes an imperfect hedge, such as the quite significant one in 2017?

You can't create a perfect hedge at low cost and investors do not want to spend their returns on achieving perfection. They would rather have some returns.

Also, if the hedge is perfect what % of additional cost p.a. would you expect to see as the hidden cost discussed in our earlier posts?

It won't be perfect; the cost of attempting it, together with the amount by which they failed, will show up as the aggregate difference in performance against the benchmark.

In some years it may be more successful and cheaper than in others.

Thrugelmir

MaxiRobriguez wrote: »

dividend yields are high relative to rest of the world.

UK companies have historically paid out a good proportion of profits compared to other markets.

MaxiRobriguez

Thrugelmir wrote: »

UK companies have historically paid out a good proportion of profits compared to other markets.

Indeed but that gap is historically at the higher end at the moment.

AnotherJoe

SlaveToMyCats wrote: »

This applies to my ISA but also to my pension.

Ideally I want to have realatively low exposure to UK and don't want my portfolio to be overly biased. But of course the currency may strengthen significantly (maybe 20%) over the next year or more which will be very poor for such a portfolio. If I could wave a magic wand I'd have an ex UK portfolio hedged against GBP movements.

Is there a sensible and 'mainstream' way I can have this and are there any major pension funds, robo advisors etc which do this for me?

Someone is providing that and they wont be doing it for free.

How confident would you be that whoever provides the hedge knows less than you about currency movements ?(because if they know more, they should come out better than you would)

[Deleted User]

Fwiw, I think sterling will be worth less in a year's time. But I'm quite sanguine about the prospect of a 20% appreciation because my house and salary, a third of my investments are various other of my family's assets are denominated in £ . In the event, I would not be richer than my next door neighbour but richer in the world.

So, for me it is entirely compatible to hedge by moving out of UK stocks or funds. I'm a big fan of companies of the type that the UK does not support but don't try to time the currency market. Through our lifetimes, sterling has been falling, and I expect it to go on falling after we're gone.

dividendhero

MaxiRobriguez wrote: »

If the currency strengthens it will be because of UK PLC sentiment improving, at which point (or because of) FTSE250 companies will outperform as their valuations are cheap and dividend yields are high relative to rest of the world.

UK valuations are cheap for a reason...money markets quite rightly view the UK as a toxic place to invest

MaxiRobriguez wrote: »

No need to hedge the currency, just over-allocate to UK domestic stocks if you think GBP will strengthen.

UK trade deficit is already one of the worst in the world at nearly 5% of GDP. It's not unreasonable to assume UK exports will fall at least 25% after Brexit...GBP might well strengthen against the likes of the Turkish Lira, but big falls against the major currencies looks pretty much nailed on