Pros/Cons of GBP-hedged equities for pension

mw24689

Hi

I'm reviewing the limited number of funds available through my workplace Scottish Widows pension.

There's nothing available that is a market cap-weighted global tracker. The closest is the SW SSGA International Equities Index (https://www.trustnet.com/factsheets/p/g733/sw-ssga-international-equity-index-pension-series-2) which is GBP-hedged. 

What are the pros/cons of being GBP-hedged for an equities fund for long-term holding in a pension? I can't get past the unknown internal costs of the hedging...

For reference, I'm aware this fund is ex-UK, and the AMC including platform fee would be 0.27%, and I'm aware of the need for hedging of fixed income assets. 

tacpot12

The principle advantage is that the performance of the fund is mostly immune to currency fluctuations. Buying into a currency hedged fund means that you are (mostly) buying the performance of the market(s) you are investing in, and not a mixture of the market performance and the currency movements.

This is the reason why you don't need to worry about the internal costs of the hedging - the internal costs are inevitable because without them you cannot removing the effect of currency movements, and your really want to do so in a product that is an investment in equities and not a product that is speculating on currency movements.

What should matter to a retail investor is that you can buy a global tracker fund that is hedged, and thereby access the global markets and hope to get something approximating the performance of each market. The hedging won't yield a perfect result, but it will be a lot better with professionals doing it than a retail investor trying to do it for themselves.

underground99

mw24689 said:

Hi

I'm reviewing the limited number of funds available through my workplace Scottish Widows pension.

There's nothing available that is a market cap-weighted global tracker. The closest is the SW SSGA International Equities Index (https://www.trustnet.com/factsheets/p/g733/sw-ssga-international-equity-index-pension-series-2) which is GBP-hedged. 

What are the pros/cons of being GBP-hedged for an equities fund for long-term holding in a pension? I can't get past the unknown internal costs of the hedging...

For reference, I'm aware this fund is ex-UK, and the AMC including platform fee would be 0.27%, and I'm aware of the need for hedging of fixed income assets. 

From the factsheet you linked, I didn't see it say it was hedged, but I didn't look at the charts to do the maths and work out whether it was.

Generally for 'long term holding' there's no need to hedge on equities imho, as the whole point of investing internationally is to take the returns of those markets rather than your home markets. That doesn't mean you couldn't take a tactical choice to hedge in the short term if you wanted to, but just that it's not really worth paying a long term premium to take a punt on what currency does best over a long term when you're deliberately trying to expose yourself to foreign markets. For equity trackers you're going to be looking at high volatility anyway. Whereas for bonds, if the point of adding bonds is volatility reduction, I can see why people are happy to hedge.

In simple terms the pros/cons are just that you may reduce volatility if you hedge, but this can cause you to miss out on returns that your unhedged peers were able to take - for better or worse. If you gamble that you should hedge you will incur some costs without an obvious 'reward', because you don't know that it will be a reward rather than a punishment. GBP weakening can take the edge off foreign market losses but if you deliberately try to hedge away that effect you can end up with a worse result than people taking the natural returns.

maxsteam

mw24689 said:

I'm aware of the need for hedging of fixed income assets. 

I'm not.

In my opinion there is no need. One option is to buy UK based companies (directly or through funds) which, while most have an international presence, if most of their trade is in UK, they will be less vulnerable to currency fluctuations. Another option is to buy equities across a range of markets so that if currencies cause one market to suffer, hopefully, another thrives.

A strong pound, for example, will usually mean that overseas assets are worth less in pound terms but it will also help companies that import into UK. My opinion is that, as long as your portfolio is diversified, you should not be overly concerned about currency fluctuations.

The "euro crisis" is generally seen as happening in 2009 and 2010. During that period the euro had a maximum value of about 92p and a minimum value of about 82p. While I don't doubt that some individual businesses faced crisis, a similar change in the value of the euro is not something that would scare me into a hedging arrangement.

It's normal for companies to blame currency fluctuations for disappointing results. Sometimes the blame is justified, sometimes it isn't.

DireEmblem

For long term investing, I dont think hedging is worth while.  There is an added cost to it - spread, interest rate differentials which I see as a headwind.

You could argue that say 10-15 odd years ago, a quid could have bought you $2, and now your $2 is worth £1.5 but that's a single currency comparison that you can never tell which way it would go.

I half see it as trying to turn an equity investment into a more bond type arrangement.

Long term if you invest globally, your pound will go up against some currencies, and down against others.  It depends what you want to do with the funds at the end of the investment.

mw24689

Thanks, everyone, for your responses - they confirm what I was thinking that GBP-hedging for equities has no obvious upside for long-term investing, and has a guaranteed downside of drag due to hedging costs.

This is the frustrating point -  Scottish Widows do not seem to offer a non-hedged global tracker. 

@underground99 - would you mind checking I've not misunderstood, but if you look at the factsheets of the sub-funds making up the fund which I linked (https://www.trustnet.com/factsheets/p/g733/sw-ssga-international-equity-index-pension-series-2), they all seem to indicate that they're GBP-hedged?

 For instance, the fund I linked comprises 66% or this fund (https://www.trustnet.com/factsheets/p/wn58/ssga-mpf-north-american-equity-index-pn), whose factsheet states "The Sub-Fund aims to track the FTSE North America ex Controversies ex CW, or its recognized replacement or equivalent, with 100% of the non-Sterling currency exposure hedged back to Sterling". That's GBP-hedged, right?

AnotherJoe

tacpot12 said:

The principle advantage is that the performance of the fund is mostly immune to currency fluctuations. Buying into a currency hedged fund means that you are (mostly) buying the performance of the market(s) you are investing in, and not a mixture of the market performance and the currency movements.

This is the reason why you don't need to worry about the internal costs of the hedging - the internal costs are inevitable because without them you cannot removing the effect of currency movements, and your really want to do so in a product that is an investment in equities and not a product that is speculating on currency movements.

What should matter to a retail investor is that you can buy a global tracker fund that is hedged, and thereby access the global markets and hope to get something approximating the performance of each market. The hedging won't yield a perfect result, but it will be a lot better with professionals doing it than a retail investor trying to do it for themselves.

I disagree. There's a cost to hedging, which cannot possibly hold back the tide for free. At best it can smooth a decline.

If Sterling declines against the dollar long term that cant be magicked away except at the cost of performance. It has to come from somewhere. Otherwise we are in free lunch territory.

Also, if currencies fluctuate about a mean, which they often seem to do, then you are paying that  cost long term literally for nothing. You pay a cost to smooth a decline, then you pay the cost to smmooth a rise, then to smooth the next  decline, then the next rise. Now you are back where you started except you've paid money you neednt have because you are back where you were.

 

Alexland

mw24689 said:

Thanks, everyone, for your responses - they confirm what I was thinking that GBP-hedging for equities has no obvious upside for long-term investing, and has a guaranteed downside of drag due to hedging costs.

I found it useful to hedge some of our investments when the pound was down to around 1.15 against the dollar about a year ago as it seemed the global media had gone into hysterics about how badly covid was going to affect the UK and there didn't seem much chance of the pound dropping further. I wouldn't bother doing it now the pound is moving around £1.40 again. Long term the movements in exchange rates will hopefully be small compared to your long term compounding investment returns.

mw24689 said:

This is the frustrating point -  Scottish Widows do not seem to offer a non-hedged global tracker.

For broader investment choice you could ask if your workplace pension rules allow partial transfers-out of lump sums into a SIPP while remaining a contributing member. This could also reduce your ongoing costs depending on how much they are currently charging and what DIY choices you make.

JohnWinder

Deleted_User said:

IMHO, hedging equities is to be avoided, and not just because of the costs involved.

.. the point of investing internationally is to diversify away from your home country. And hedging can defeat that purpose, because it ties the value of all your overseas investments to the value of your home currency.

Au contraire. Isn't it not hedging that can threaten the benefits of investing internationally; I'm thinking the Japanese investor at the start of 30 years of yen appreciation? Being UNhedged ties some of the value of your overseas investments to the value of your home currency (valued against other currencies), I think we can say. 

Hedging costs, yes. And in view of the usual favourable and unfavourable fluctuations in exchange rates, as well as there being several currencies the international investor is likely involved with, we can probably say that over the long term you'd be better off unhedged. But can we always hang out for the long term to arrive? In view of the uncertainty I can see the case for having some hedged and some not.

Thrugelmir

Once in drawdown will you sleep comfortably at night ?  That's the key question.  Until you've experienced the full rollercoaster of currency movements and the impact on your portfolio. Any answer is subjective.  

underground99

mw24689 said:

Thanks, everyone, for your responses - they confirm what I was thinking that GBP-hedging for equities has no obvious upside for long-term investing, and has a guaranteed downside of drag due to hedging costs.

This is the frustrating point -  Scottish Widows do not seem to offer a non-hedged global tracker. 

@underground99 - would you mind checking I've not misunderstood, but if you look at the factsheets of the sub-funds making up the fund which I linked (https://www.trustnet.com/factsheets/p/g733/sw-ssga-international-equity-index-pension-series-2), they all seem to indicate that they're GBP-hedged?

 For instance, the fund I linked comprises 66% or this fund (https://www.trustnet.com/factsheets/p/wn58/ssga-mpf-north-american-equity-index-pn), whose factsheet states "The Sub-Fund aims to track the FTSE North America ex Controversies ex CW, or its recognized replacement or equivalent, with 100% of the non-Sterling currency exposure hedged back to Sterling". That's GBP-hedged, right?

SW's own factsheets don't mention it being hedged, either for the SW SSGA International Equity Index or the SW SSgA North America Equity Index that they offer. The fact that you have found through trustnet an SSGA factsheet for a North American Index product with 100% hedging does not mean that's the one the SW version of the fund is using; it is not prefixed with SW or Scottish Widows. If you google some more you will also find one that says 75% hedging and perhaps there are others.   

The SW fund factsheet says that the investment is solely in the SSgA International Equity Index Fund and is made on an index-tracking basis, doesn't mention it being a hedged product.  If you look at a SSGA factsheet such as https://www.ssga.com/library-content/products/factsheets/mf/emea/factsheet-emea-en_gb-gb00bdclhx38.pdf (renamed a few months ago) it says it is getting its exposure from other SSGA subfunds (including a North America one) but it doesn't mention being hedged and its performance does not look like it's hedged.  For example its 5 year benchmark return to March is 103% in GBP which would be broadly consistent with FTSE's own factsheet for FTSE World Ex-UK (https://research.ftserussell.com/Analytics/Factsheets/Home/DownloadSingleIssue?issueName=WIXUKS&IsManual=false) ; the FTSE factsheet is in USD and shows 96% return over 5 years to March and you'd expect an unhedged sterling one to report a few percent higher than that as sterling weakened - which the SSGA one does.