To hedge or not to hedge?

fcjf

I have a DC pension from a liquidated employer which is sitting in the deferred section of the Wills Towers Watson Lifesight Pension trust.

I cannot remember the specifics of how the fund selection came about but I have two versions of the Developed Market Equity Fund one of which is Hedged and the other Unhedged. The underlying fund for these are the L&G World developed Equity Index Fund – GBP Currency Hedged and Unhedged. I hadn’t really given this split too much consideration as the initial fund allocations were similar and the growth %’s over the past few years has been very similar. This has now changed with the performance of the hedged fund dropping nearly 15% below the unhedged fund when measured over the past 12 months (-1.03% / -15.66%).

What I am trying to understand is what is done to the different funds to make them Hedged / Un-Hedged and should I take any action with the hedged fund, or given that I have similar number of Units in each will this even itself out over time?  It is worth saying that I am happy enough being invested 100% in world equities in this pension account and have for some time now been planning to transfer these funds into my SIPP but never got round to it so if I need to take some action I guess I should factor that into whether I transfer in specie or as cash and select new world equity funds?

[Deleted User]

Hedging means that the fund uses currency futures to negate the effect of currency fluctuations on your gains and losses.  Normally, if sterling drops vs USD, your US stocks fund value would jump when counted in GBP but not if its hedged.  And the other way around.

Hedging is an attempt to time the markets and, in the long term, its going to have a negative effect.  This is because trading futures results in extra costs for no expected gain.  In fact, having stocks within your portfolio which are traded in different currencies should improve diversification and reduce volatility, so hedging is counterproductive. 

There is an argument for hedging foreign bonds, if you hold any.  This is because bonds play a different role in the overall portfolio. 

leosayer

The hedged versions remove the effect of foreign exchange movements on the fund price by entering into foreign exchange forward contract.

Most global equity funds hold more than 60% of their value in companies quoted on US markets which have their market price set in USD eg. Tesla, Microsoft, Alphabet (Google) etc. Your fund is priced in GBP so every days when the administrator calculates the value of the fund, it has to convert the value in USD to GBP using the current exchange rate. 

Recently, USD has strengthened against GBP hence why your unhedged fund has remained largely flat even when US markets have dropped significantly. The price of your hedged version more closely follows the performance that a US-based investor would have experienced.

There's no element of market timing for currency hedging used by index funds. Firms use an algorithm to decide how much to hedge based on fixed tolerances and targets. 

I hold the same fund - unhedged only. There are different schools of thought about whether it's worth hedging or not. I don't think it's worth doing with equity funds. 

fcjf

Thank you for the replies, I have a greater understand of Hedging now and why the last week has had such an impact on my Hedged fund. I also picked up this Monevator article if anybody else is looking for some reading on the subject Don't currency hedge your equity portfolio - Monevator

Question for me now is do I ride out the current situation for the next few weeks or sell the hedged units and purchase the unhedged units now? This would crystallise my losses in the past couple of weeks however, the graph below shows the performance for the past year and there has only been one occasion where the Hedged fund went up whilst the unhedged fund went down so it is difficult see to see any upside of keeping the hedged fund any longer. Would there be any event where the Hedged fund would perform better than the unhedged version?



 

[Deleted User]

fcjf said:

Thank you for the replies, I have a greater understand of Hedging now and why the last week has had such an impact on my Hedged fund. I also picked up this Monevator article if anybody else is looking for some reading on the subject Don't currency hedge your equity portfolio - Monevator

Question for me now is do I ride out the current situation for the next few weeks or sell the hedged units and purchase the unhedged units now? This would crystallise my losses in the past couple of weeks however, the graph below shows the performance for the past year and there has only been one occasion where the Hedged fund went up whilst the unhedged fund went down so it is difficult see to see any upside of keeping the hedged fund any longer. Would there be any event where the Hedged fund would perform better than the unhedged version?

Yes.  Assuming the share price stays the same while GBP goes up vs a basket of other currencies, the unhedged version would outperform. 

However, over long periods of time (decades) the unhedged version is expected to outperform while delivering better results with reduced volatility.  This is why only people who believe in market timing would be using the hedged versions (not counting the uninformed): they would try to move in and out of hedging, depending on what they believe currencies might do next. In fact, exchange rates are not predictable so its a bad idea.  

If it was me, I would sell the hedged version and buy the unhedged version of the fund right away.

MarkCarnage

I agree with @Deleted_User. 

Albermarle

and have for some time now been planning to transfer these funds into my SIPP but never got round to it

Probably the funds will be better off in a modern SIPP. When the time comes to withdraw, the SIPP will probably have more options available.

Possibly the online access will be better ?

Possibly the charges will be cheaper?

JohnWinder

You’ve had, and have, some investments you didn’t understand the nature of, which is a bad situation to be in unless you out-source your investment decisions to an advisor. Don’t continue without a much better understanding lest you do yourself a financial disservice. However much you read this forum, spend some time away from it educating yourself about personal investing; it’s not rocket science, but there are a few traps.

I have a greater understand of Hedging now and why the last week has had such an impact on my Hedged fund........Would there be any event where the Hedged fund would perform better than the unhedged version?’

However greater your understanding was it fell far short of what you need if you need to ask that question which Mordko answered for you.
Recency bias is a hazard for investors: the recent past distorts one’s view of the real world because it makes a big impression on one. Equity investing is for years, not months, but you’ve considered only the last 12 months of your funds’ performances; that’s not even recency bias, that’s completely ignoring the longer term past if you’re trying to get a feeling for how the two funds perform.
Yes, that’s a useful article from Monevator. But of his three ‘natural hedges’, two of them, your own home and your salary are not investments when you’re retired because you have no salary and you can’t sell a bedroom of your home nor does it produce income. It’s an asset, not an investment. So do look critically at what he writes.
He say’s ‘For the same reason, the FTSE100 usually goes up when Sterling falls. That’s because most of the FTSE 100’s earnings are actually in USD.’ But have a look at this year, both are down.
Would the same ‘don’t hedge equities’ have been valid for a Japanese woman forty years ago? She’d have wept for four decades as the yen appreciated against the dollar steadily gobbling up the returns from foreign equities because she had no currency hedging. Unless you know what the pound will do for the next decade or two you’re betting it won’t appreciate.
We’d be better off if all our foreign equities were unhedged if the pound stays this weak or weakens over the coming decades, and we’d be better of hedged if it doesn’t. Choosing either one is a bet. If you wanted to ‘hedge your bets’ in common parlance, you’d have both. I’m not convinced unhedged equities are necessarily the right choice.
Without a better understanding of this you’re about to make a loss by selling after a fall, which could then be followed by another loss if you decide to return to hedging after a period when unhedged equities do a lot better. Whatever you decide don’t make a second bad choice add to the damage if there’s a first one.

[Deleted User]

A good point. When people buy a car,, they tend to do a lot of research, test drive and look under the bonnet.

With investments some spend 5 or 10 cars  worth of dosh without “looking under the bonnet”.  Not sure why this happens.  Information is readily available and its their family’s happy retirement thats at stake.  

Don’t have a lot of time?  Fine.  Spend 1-2 hours reading the Edwards book and buy the simplest investment product on the market.  Thankfully its very easy in 2022.

Someone buying products which hedge/trade futures, etc should spend quite a bit of time to really understand whats under the bonnet and have an informed opinion before investing.

redpete

The relative strength in any national or regional economy is reflected in the underlying equity prices and the strength of their currency.  If you are spreading your money across regions for diversity with periodic rebalancing (sell off expensive funds, buy more cheap funds) then I don't see the point of paying for hedging against the natural ebb and flow of markets - you are planning to use your rebalancing to do this.