Investing Abroad

AnotherJoe

chiang_mai said:

The US market is too big to buy funds and hope that you might have found one that will outperform, I think it's better to buy an index such as the S&P. And since you can buy into those funds in Sterling, why add the extra risk of currency exchange. I hold Legal and General US Index which tracks the S&P which is denominated in GBP.

The point is, currency exchange is factored into the GBP price you pay and that you see every day.

If the pound rises 1% for example, then your fund will fall 1%, except of course the fund will be doing its own thing regarding the shares within it, so you wont notice that as its swallowed up by the natural movements of the fund. 

chiang_mai

AnotherJoe said:

I think this is a false question, because if instead of separate shares you had a generic global fund, something like 95% of that would be in foreign currencies, it just wouldnt  be immediately noticeable because you are buying in GBP, but ultimately, theres an Fx cost you are paying its just hidden. Even if you only bought UK shares, then most of those will be greatly affected by Fx as well anyway.

So this is inescapable, so dont worry about that aspect of it.

What you might think about more is, are these long term buy and hold or are you trading? If you are trading you want an account where you can buy and sell in dollars (In your case) so you only pay teh Fx cost once, when you initially put GBP in. Then when you buy Acme in dollars and later sell, the dollars come back into your dollar account and you can buy Beta Corp in dollars without needing to have another FX cost twice.

It's one thing for the Fund Manager to hedge his investments back to GBP in order to manage his funds currency risk, it's another thing entirely for the man in the street to try and do the same thing at the fund buying level. The former is in the hands of an experienced FM, the latter is pure guesswork and luck. I agree with the OP, he is right to identify the currency risk of investing in USD.

The second aspect is tax. As a UK citizen investing directly in USD denominated shares tI'm pretty sure he OP will be liable to withholding tax which is not recoverable.

Thrugelmir

chiang_mai said:

The US market is too big to buy funds and hope that you might have found one that will outperform, I think it's better to buy an index such as the S&P. And since you can buy into those funds in Sterling, why add the extra risk of currency exchange. I hold Legal and General US Index which tracks the S&P which is denominated in GBP.

The underlying investments are traded on international markets in US $. The fund manager will price the units at GDP at the prevailing exchange rate.  You are exposed to fluctuation in daily exchange rates.  You would need to pay for hedged fund to avoid this exposure. Though the cost of providing this assurance will diminish both returns and potential losses. 

underground99

chiang_mai said:

 And since you can buy into those funds in Sterling, why add the extra risk of currency exchange. I hold Legal and General US Index which tracks the S&P which is denominated in GBP.

The S&P is denominated in dollars. If they continually recalculate how many pounds the dollars are worth, while exchange rates go up and down, to publish a price that tells you each day what is sterling equivalent of the dollar value of the US shares held in the fund... You're not avoiding any 'risks of currency exchange'.

You're just being kept informed how many pounds your dollar investments in Microsoft and Apple and Wells Fargo and Walmart are worth at a point in time, so that when you sell your shares in the fund or buy more of them you know how many pounds you'll get or pay, which will be derived from the underlying dollar value and dollar-sterling exchange rate at the time. Either you see movement in currency exchange rates as a 'risk', or not - but if it's a risk, it's not a risk avoided by using an unhedged fund that happens to publish its price in pounds.

underground99

chiang_mai said

The second aspect is tax. As a UK citizen investing directly in USD denominated shares I'm pretty sure he OP will be liable to withholding tax which is not recoverable.

You may misunderstand. A UK resident such as the OP can use the UK-US tax treaty to  reduce the withholding tax on directly held US shares to 15%, or to 0% if held through a self invested personal pension, and in the case of the 15% can offset that withholding tax from his UK tax bill on the same income, if he has such a bill.

The UK resident can't reduce his exposure to US withholding tax if he uses a fund such as the L&G Index tracker to hold the shares in the US companies; the fund will simply have to pay the appropriate US withholding tax for its status when receiving the dividends, before it has a chance to pay the remaining income to the fund's investor... that net income eventually received by the UK resident being UK taxable on the UK resident.

Still, the potential tax inefficiency of using collective investments such as funds or ETFs or investment trusts as a middleman to hold US investments is made up for by the efficiency and diversification benefits, compared to having to arrange purchases of small amounts in a large number of directly held stocks to make the same sort of portfolio yourself. 

chiang_mai

underground99 said:

chiang_mai said

The second aspect is tax. As a UK citizen investing directly in USD denominated shares I'm pretty sure he OP will be liable to withholding tax which is not recoverable.

You may misunderstand. A UK resident such as the OP can use the UK-US tax treaty to  reduce the withholding tax on directly held US shares to 15%, or to 0% if held through a self invested personal pension, and in the case of the 15% can offset that withholding tax from his UK tax bill on the same income, if he has such a bill.

The UK resident can't reduce his exposure to US withholding tax if he uses a fund such as the L&G Index tracker to hold the shares in the US companies; the fund will simply have to pay the appropriate US withholding tax for its status when receiving the dividends, before it has a chance to pay the remaining income to the fund's investor... that net income eventually received by the UK resident being UK taxable on the UK resident.

Still, the potential tax inefficiency of using collective investments such as funds or ETFs or investment trusts as a middleman to hold US investments is made up for by the efficiency and diversification benefits, compared to having to arrange purchases of small amounts in a large number of directly held stocks to make the same sort of portfolio yourself. 

I had forgotten about the dual tax aspect, I'm offshore so am unable to take advantage of that.

chiang_mai

underground99 said:

chiang_mai said:

 And since you can buy into those funds in Sterling, why add the extra risk of currency exchange. I hold Legal and General US Index which tracks the S&P which is denominated in GBP.

The S&P is denominated in dollars. If they continually recalculate how many pounds the dollars are worth, while exchange rates go up and down, to publish a price that tells you each day what is sterling equivalent of the dollar value of the US shares held in the fund... You're not avoiding any 'risks of currency exchange'.

You're just being kept informed how many pounds your dollar investments in Microsoft and Apple and Wells Fargo and Walmart are worth at a point in time, so that when you sell your shares in the fund or buy more of them you know how many pounds you'll get or pay, which will be derived from the underlying dollar value and dollar-sterling exchange rate at the time. Either you see movement in currency exchange rates as a 'risk', or not - but if it's a risk, it's not a risk avoided by using an unhedged fund that happens to publish its price in pounds.

The L&G S&P Tracker (and many funds like it), buy shares in the companies that comprise the parts of the S&P they wish to track rather than attempting to track the S&P proper. The fund then uses derivatives to hedge back into Sterling. The L&G fund holds about 580 different company shares which are repriced once per day. 

underground99

chiang_mai said:

underground99 said:

chiang_mai said:

 And since you can buy into those funds in Sterling, why add the extra risk of currency exchange. I hold Legal and General US Index which tracks the S&P which is denominated in GBP.

The S&P is denominated in dollars. If they continually recalculate how many pounds the dollars are worth, while exchange rates go up and down, to publish a price that tells you each day what is sterling equivalent of the dollar value of the US shares held in the fund... You're not avoiding any 'risks of currency exchange'.

You're just being kept informed how many pounds your dollar investments in Microsoft and Apple and Wells Fargo and Walmart are worth at a point in time, so that when you sell your shares in the fund or buy more of them you know how many pounds you'll get or pay, which will be derived from the underlying dollar value and dollar-sterling exchange rate at the time. Either you see movement in currency exchange rates as a 'risk', or not - but if it's a risk, it's not a risk avoided by using an unhedged fund that happens to publish its price in pounds.

The L&G S&P Tracker (and many funds like it), buy shares in the companies that comprise the parts of the S&P they wish to track rather than attempting to track the S&P proper. The fund then uses derivatives to hedge back into Sterling. The L&G fund holds about 580 different company shares which are repriced once per day. 

"The objective of the Fund is to provide growth by tracking the capital performance of the FTSE USA Index (the “Index”). This objective is after the deduction of charges and taxation."

The index it tracks is, as you say, about 580 stocks, which is a little broader than the well known S&P500, and narrower than the S&P total market index of about 3800 stocks. They aim to deliver the result of this index (acknowledging that they'll suffer some withholding tax and have ongoing management fees and operating costs so will lag the index a little).

This objective is, as you say, broadly the same as 'many funds like it'; some track S&P500, some FTSE USA, some S&P Total Market, some FTSE North America.

What they don't do, is 'hedge' the investment returns back to sterling. They do have the general ability to use derivatives and hedging but will not use it to any significant extent because it would mean they'd fail to deliver the proper result of the index translated to pounds. They simply calculate and publish a price in sterling to make it easier for UK investors to monitor how it's doing in their own currency.

The OP could monitor the price of his US shares in pounds too, by getting a portfolio summary from his broker in pounds rather than dollars, but paying pounds to buy the asset or being told its current value translated to pounds or selling it and recieving pounds, doesnt avoid risk of currency appreciation or depreciation. It's just an easier method of keeping score.

Putting it another way, publishing the price in sterling doesn't mean you have eliminated any currency risk whatsoever. It just means that someone has told you how many sterlings the dollar investments are currently worth at today's exchange rate, and will do so again tomorrow and the next day. Every time they give you a price, they tell it you in pounds. But that does nothing to eliminate currency risk when the underlying assets are all in dollars.

If the investments are worth about the same amount of dollars tomorrow or a year from now because the companies' dollar prices are about the same as they are today, but the pound strengthens to be worth $1.60 instead of $1.40, all the assets of the fund will collectively be worth fewer pounds. Friday's total assets of about £4.5 billion would then only be worth £3.9bn at the new exchange rate. They will have to update the published price of the fund's Class R Accumulation units from 691p to about 605p to reflect that the assets represented by each unit in the fund are now worth fewer pounds. If you were invested in the fund while the market exchange rates changed in that way, you would have lost about an eighth of the value of your investment.

The fact that the fund published its price in pounds and lets people buy it or sell it in pounds does not mean those people have avoided exchange risk. If a dollar depreciates 12.5% from being worth 71p today (£1=$1.40) to only being worth 62p tomorrow (£1=$1.60), then the "$236 each" Microsoft shares held by the fund which are currently worth £168.50 each will only be worth £147.50 each, and likewise for all the other stocks held. The fund price will drop 12.5%.

This loss is unavoidable because the L&G US Index Trust fund doesn't hedge its US assets back to pounds. If it did hedge its assets back to pounds, it would not achieve its objective which is to track the result of an index of US stocks. The sterling value of the US stocks changes constantly as the FX rate changes, and so will the GBP price of the index fund.

You can look at the fund performance against the USD factsheet of the index it tracks.

Here is the FTSE USA factsheet:
https://research.ftserussell.com/Analytics/Factsheets/Home/DownloadSingleIssue?issueName=WIUSA&IsManual=false

You can see that the calendar year performance of the index for 2020 was a little over 20% measured in dollars.

Here is the Morningstar factsheet for the fund.
https://www.morningstar.co.uk/uk/funds/snapshot/snapshot.aspx?id=F0GBR06HX4&tab=1
 Under the Performance tab you can look at Annual Returns (GBP) and see the calendar year 2020 was 16.11%. (this is for the "I Class Accumulation" which has low charges of 0.1%)

You could also look at L&G's retail website for the more expensive "R Class Accumulation"
https://fundcentres.legalandgeneral.com/uk/Private/fund-centre/Unit-Trust/US-Index-Trust/
Look at Calendar Year Performance and for 2020 it was 15.65%. It's a lower return than the Class I because the Class R running costs are about 0.4% higher.

So we know the index of the 580 stocks it's tracking delivered 20+% in dollars but the fund only gave a UK investor about 16% in pounds. A fraction of a percent would be lost to running costs (ongoing charges) and another fraction of a percent on withholding taxes on the dividends it received. There is also a small effect that the FTSE index is calculated at end of day while the L&G fund calculates its daily price at 3pm. But prices don't move 4% in a few hours. So what is the reason a GBP investor had a worse return than the US investor?

That's right, it's because the GBP investor has lost money on the exchange rate changing. 
A pound would buy $1.336 at 31/12/19 but $1.386 at 31/12/20, so dollars became worth fewer pounds over the course of the year ; GBP investors lost on the dollar depreciating.

So $100 in the index became worth over $120, dividends reinvested, but  £100 in the fund was worth only £116 at the end of the year. If the $100 of US shares had stayed at $100, the GBP investor would have lost money. 

Your contention that you can simply buy a normal US index fund that happens to be priced in pounds, such as the L&G US Index Trust, and thereby 'not take the risk' of currency moving against you, is false. The risk is there, like it or not.  You *could* find a GBP hedged version of some US or global funds, which will incur hedging costs to reduce FX rate movements - some might do it more successfully than others, and the hedging may cost more than the gains from it - but the one you pointed out is not such a fund.

chiang_mai

" They do have the general ability to use derivatives and hedging but will not use it to any significant extent because it would mean they'd fail to deliver the proper result of the index translated to pounds". 
Your argument appears compelling, I'm surprised it is not fully hedged.
Separately though: the fact a hedged return would not precisely mirror the Dollar equivalent return of the index seems a small price to pay for having a hedged fund, that was the game I thought I was in. It's not that I don't buy your argument, I do, but I will do some further checking to see what else I can find on this and report back.

underground99

chiang_mai said:

" They do have the general ability to use derivatives and hedging but will not use it to any significant extent because it would mean they'd fail to deliver the proper result of the index translated to pounds". 
Your argument appears compelling, I'm surprised it is not fully hedged.
Separately though: the fact a hedged return would not precisely mirror the Dollar equivalent return of the index seems a small price to pay for having a hedged fund, that was the game I thought I was in. It's not that I don't buy your argument, I do, but I will do some further checking to see what else I can find on this and report back.

A GBP priced class isn't the same as a GBP hedged class. It's an administrative convenience rather than a fund strategy and L&G don't say they are aiming to deliver the result of the index hedged to sterling. They just have some catch-all language to say that the manager might use hedging or derivatives to achieve the objective, as they say for most international funds they offer, regardless of whether they use it or not. Then investors have less grounds for complaint if something goes wrong because they can't say they weren't aware that derivatives might be used in pursuit of a goal.

As the goal for L&G is to deliver the result of the index rather than the result of index hedged to GBP, you can assume there won't be any material use of hedging otherwise it would give them a massive tracking error against the underlying raw index they purport to track.

iShares and v Fidelity both offer GBP hedged classes for an S&P500 tracker. But often the hedging is only rolled forward a month at a time and can be quite imperfect, giving errors in either direction. You can get lucky and get a better result than you deserve, and other times you can do worse than the theoretical hedged result which can in turn be worse than just taking the underlying actual result. If sterling appreciates you will /generally/ be better to have used the hedged class rather than un-hedged, if the hedge is any good. But you can't know that it will save you more in the bad years than it costs you in the good.