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Pros/Cons of GBP-hedged equities for pension
Comments
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If you take a holistic approach, you will see that you are unavoidably heavily invested in £ (assuming your house, state pension, money under the mattress etc are valued in sterling). Then, you never have to worry about currency fluctuation. So underground delivers good news, copacetic.0
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tacpot12 said: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.I don't agree - if you are trying to weigh up the pros and cons of hedging then the internal costs are very much a factor. By internal costs I mean - and I assume others mean - the hidden cost of the forex transactions, while the external cost represents a possibly higher OCF.Say you were considering hedging for a fund you expect to hold for ten years and you find out the internal cost averaged 0.75% pa. You would ask yourself whether 7.50% less growth (or greater loss) of the fund is a price worth paying for the hedge. You may reach a different conclusion if the annual cost is 0.10%, 0.75% or 1.25% pa. So you should worry about, or at least consider, those internal costs.0
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Deleted_User said:When you look at owing equities as owning a percentage of a business (or of many businesses), a Japanese investor who buys US shares and doesn't hedge currency is getting exactly the same return as a British investor who does the same thing. Even if the yen rises, while the £ falls.......This hedging reduces short-term volatility; but IMHO it doesn't reduce long-term risk: it increases it, by (as I said) tying the value of all your overseas investments to your home currency. To my mind, currency-hedged equities look like 2 things combined: "proper", unhedged equities + currency speculation.The Japanese and the Brit buy $100 of US shares on the same day, using their own currencies. The shares increase in value by 20% during the next five years, during which time the yen rises (against the $) and the GBP falls against the $. They both smile at the 20% return provided by the successful US business, as it’s time to sell, but the Jap only gets a return of 10% because of currency appreciation, and the Brit gets 30% return. We’re not sharing the same meaning of ‘return’.Unfortunately it's not always ’short-term’ volatility, as when the overwhelming trend in the yen/$US rate rose for several decades, a period beyond most people’s retirement horizon which was what the original question was about - hedging in a pension fund.To my mind, currency-hedged equities look like 2 things combined: "proper", unhedged equities + currency speculation.Change ‘equities’ for bonds in that sentence, and tell why everyone thinks you should hedge foreign bonds to remove the currency volatility that can swamp the underlying value stability.Hedging is insurance: you pay to protect against unfavourable currency movement. If there’s favourable currency movement, you’ve wasted your money. It’s the same as insurance against a house fire. Insurance is one way to reduce this sort of risk, that’s why hedging is a risk reduction strategy, I think.
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JohnWinder saidHedging is insurance: you pay to protect against unfavourable currency movement. If there’s favourable currency movement, you’ve wasted your money. It’s the same as insurance against a house fire. Insurance is one way to reduce this sort of risk, that’s why hedging is a risk reduction strategy, I think.
So in a situation where you didn't need the insurance because sterling was flat, you have just spent the insurance premium, but in a situation where you didn't need the insurance because sterling weakened and your dollars or euros became worth more pounds, you have spent the insurance premium and given up the extra pounds that the unhedged person would have got. Which feels like a double whammy.
Effectively whether the FX market is up, down or flat you are spending the premium to run the strategy, so effectively paying money to buy lower short term volatility, which is a strategy that some would be happy with.
But a clumsy analogy the double whammy of buying that type of insurance would be: paying a monthly premium to get employment income protection (eg lost job or take a 10% pay cut, it tops you back up)... but also by signing up for the protection, the insurance company takes your pay rises or bonuses and keeps you at your original salary. So the cost of buying the insurance to protect the downside is missed opportunity on the upside, as well as the premium itself.
There's nothing wrong with paying money to buy a particular outcome (e.g. dampening the currency volatility) but if you are using equities for the long long term then volatility can often be 'ridden'. I'm not denying the examples you quoted about long term changes for some currencies eg Japan - but generally part and parcel of participating in global equity markets is having income and assets denominated in [global currency basket] which allows you to meet future liabilities denominated in [global currency basket].
In later life / retirement you will still be buying goods and services which have cost components driven by sales prices in other global economies which are denominated in [global currency basket] and so, trying to fix all your assets at today's rate of GBP to [global currency basket] may be heavily counterproductive. Seems more logical to decide on your domestic / international equities split and then let the international equities be worth what they are worth on a global stage, as a way of funding future imports / imported inflation.
But there is more than one way to skin a cat.2 -
Can't quibble with any of that, and you raise a good point: the 'home bias' you have. If you live in a country whose market capitalisation is 5% of global, and your equity investment is global cap weighting, then you're exposed to more currency risk than having 50% of equities in home currency and the other 50% in foreign currencies. As well as cats, it's horses for courses.0
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That's a good point introducing inflation adjustment to consideration of returns; better late than never. I was thinking in nominal returns. But I'm not sure it helps justify not hedging in any way that we haven't already acknowledged.I’m not sure it’s valid to compare the Japanese investor and the UK investor in the way you have with inflation/deflation considerations.Thinking aloud….if the Japanese investor loses 2%/year on average for returns for 30 years from unhedged currency movement, she needs to recoup that with an equivalent 2%/year reduction in inflation rate than would otherwise occur if there were currency neutrality. I don’t see that whatever happens to the UK investor and their inflation rate is relevant to the Japanese.If this 2%year loss due to unhedged currency movement for the Japanese occurred for 30 years, they would need the inflation rate to keep dropping by 2%/year for 30 years also - seems impossible. If the inflation rate dropped 2%/year for only one of those thirty years and stayed at that level (that's about what happened), then the investor is suffering an unhedged currency related loss for 29 years.0
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Yes, I now see the mechanism you're envisaging. A different way of thinking about 'real returns', by extending it to purchasing power when one includes one's own inflation rate.Thinking aloud....for this to work, in a qualitative sense only, as 'non-hedging' protection against one's currency appreciating, one needs home country deflation if you have home country currency appreciation. Now, does it help to have your deflation boosted by the other country having high inflation? Not sure, but perhaps other country high inflation helps push that country's nominal returns higher. Head spinning.0
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