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Do I want a Hedged Version of a Fund or not?

Investment discussion for beginners. Why you should invest your money, get help getting started
tug7
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Do I want a Hedged Version of a Fund or not?

#227959

Postby tug7 » June 8th, 2019, 12:41 pm

I have been looking at a variety tracker funds and I find that some are available in both hedged & unhedged (US $) form. This has made me realize that I don't really know what hedging means.

I know the simple bit about protecting against currency exchange rate movement but that doesn't get me far.

During the period of my financially aware life the Sterling/ Dollar exchange rate has fallen from around $2.80 = 1 UK pound to around $1.27 and has been lower still. The long term trend is however definitely down.

If I had held a single dollar denominated fund for that entire time which had paid dividends throughout what would a hedged fund actually have done for me?

monabri
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Re: Do I want a Hedged Version of a Fund or not?

#227976

Postby monabri » June 8th, 2019, 1:25 pm

tug7 wrote:During the period of my financially aware life the Sterling/ Dollar exchange rate has fallen from around $2.80 = 1 UK pound to around $1.27 and has been lower still. The long term trend is however definitely down.



If that's your belief (bold text above) , then don't you actually want a non-hedged fund? (and it'd be cheaper because there would be no hedging cost). If Sterling weakens further, it means the units you bought in Vanguard/iShares today become more valuable in your native currency (Sterling).

For example, suppose a unit in a V'Guard fund at the "start of your investment life" was $1 and the exchange rate was £1 = $3 (rounded up for argument sake) - you could buy 3 units which you stash away for n years.

However, in 2019, you now decide to cash in those 3 units bought years ago and you get £3 back on your original £1 investment...assuming $ to £ parity as Sterling weakens further.


For a new buyer in 2019 - (Hypothetical case) as Sterling weakens and the the pound drops to parity with the dollar, you could only buy 1 V'Guard unit.

The danger is if Sterling improves (Brexit outcome is more benign) - and in n years you decide to cash in your VG units - they convert units in dollars to a more expensive Sterling. Not favourable.


So- if Sterling were to improve, do we need to consider buying a hedged fund and at what extra cost and what does this extra cost buy us?

(I don't know the answers to this!)

tug7
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Re: Do I want a Hedged Version of a Fund or not?

#227993

Postby tug7 » June 8th, 2019, 2:23 pm

I don't think that I do want a hedged fund but my thinking in ignorance is not the key to good decisions and so many recommend hedged funds! I guess this is because they think that I spend in £'s but this ignores the inflation effect of currency movement.

I am trying to largely ignore brexit as short term noise with nasty long term implications but the long term trend of sterling (both before the EU & during it) is down.

So we are saying that if the underlying dollar assets stayed the same price (in dollars) that the UK hedged fund price would not be static but would reflect any change in exchange rate?

So in my original example of sterling going from $2.80 to $1.27 -( & excluding all fees & other complications) an original investment of £100($280) that is still worth $280 would in a non hedged fund be valued at $280 / 1.27 - £220 and in a hedged fund today would be £100?

I recognise that if sterling went back up the reverse would be true

I know this is so basic but my brain isn't what it once was!

richfool
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Re: Do I want a Hedged Version of a Fund or not?

#228006

Postby richfool » June 8th, 2019, 3:20 pm

I too tend to favour unhedged investments.

Historically sterling has continued to weaken and I take the view that it is probably likely to continue to do so.

If I am wrong and it doesn't and it strengthens instead, then I will gain in other areas, like cost of foreign travel & holidays etc (reducing). So that should offset any slight loss of value in my investments, and noting that my investments and the dividend income arising from them is well diversified anyway.

LooseCannon101
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Re: Do I want a Hedged Version of a Fund or not?

#228042

Postby LooseCannon101 » June 8th, 2019, 8:48 pm

I don't hedge directly, but I do own assets (equities) in many different countries through a large global equity fund with over 450 individual holdings.

Hedging will cost money like all insurance products, and won't necessarily provide a higher return. For better or worse, the US market dominates the world at the moment, with US equities forming over 50% of the world's market, whilst the UK is only 6%.

Diversity of investment IMHO is a better policy than taking out multiple insurance products.

tug7
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Re: Do I want a Hedged Version of a Fund or not?

#228066

Postby tug7 » June 9th, 2019, 9:17 am

Thanks.

I am now pretty sure that I don't want a hedged fund although I am still not sure that I understand exactly what it does & doesn't do.

PhaseThree
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Re: Do I want a Hedged Version of a Fund or not?

#228084

Postby PhaseThree » June 9th, 2019, 10:19 am

I'm not sure I agree with that assessment. For the last thirty-ish years up until the Brexit referendum the Pound/Dollar exchange rate had been trading in the 1.4-1.8 ish range (It was briefly trading above 2 as recently as 2008). Following the Brexit chaos this has dropped to 1.27. A recovery to 1.5 which would be at the lower end of the 30 year average would represent a 20% hit in GBP terms.

https://www.macrotrends.net/2549/pound- ... ical-chart

I've been looking at VWRL but have decided that buying a dollar denominated ETF at this time is too risky. As there is no GBP hedged version of VWRL I will probably go with IWDG (Sterling hedged MSCI world tracker) with a TER of 0.3% and accept the additional 0.05% cost for the next few years while things settle out.

Alternatively I may just continue to prevaricate and sit in cash for the next year !

mc2fool
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Re: Do I want a Hedged Version of a Fund or not?

#228097

Postby mc2fool » June 9th, 2019, 11:43 am

tug7 wrote:I am now pretty sure that I don't want a hedged fund although I am still not sure that I understand exactly what it does & doesn't do.

Yes you do, at least in theory and, as you say, excluding all fees & other complications. Your $2.80 to $1.27 is essentially correct, except that's the theory and the fees & complications make it less than perfect. If you google for currency hedged ETFs you'll find a fair few explanations, including these two:

http://www.morningstar.co.uk/uk/news/129223/how-etf-currency-hedging-works.aspx
https://www.justetf.com/uk/news/etf/why-currency-hedged-etfs-are-rising-in-popularity.html

The main "complication" is that many currency hedged funds use monthly forward contracts for the hedging and so will (and, to be fair, only claim to) only reduce the effect of currency movements, not eliminate them (and, of course, that could work out for the better or for the worse). E.g. read the Investment Objective, Important Information, and KIID for https://www.ishares.com/uk/individual/en/products/251892/ishares-msci-world-gbp-hedged-ucits-etf

So, bottom line is that they do (more or less) what you think they should, but less than perfectly, and at a cost. Whether that'll work out for the better or worse overall only time will tell....

colin
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Re: Do I want a Hedged Version of a Fund or not?

#228316

Postby colin » June 10th, 2019, 12:08 pm

My understanding thanks to a previous post by Hiriskpaul is that the cost of currency hedging is linked to the differential between interest rates of the two currencies, as US interest rates are lower than ours then that adds an additional cost, looking at the performance difference between hedged and unhedged versions of the same ETF this seems to add a 2% drag on performance from the sterling hedged against dollar version but compare ETFs yourself even if that is nor what you intend to buy.

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Re: Do I want a Hedged Version of a Fund or not?

#228452

Postby WorkShy » June 10th, 2019, 6:10 pm

While the OP is correct the trend for GBP has been weaker over the past thirty years, it's worth noting that on a trade weighted basis GBP has not been this weak since 1984/85. So this could be considered a fairly sub-optimal point to be taking on more foreign fx exposure. Of course Brexit is a constant source of fx volatility but that can cut both ways for GBP.

colin wrote:My understanding thanks to a previous post by Hiriskpaul is that the cost of currency hedging is linked to the differential between interest rates of the two currencies, as US interest rates are lower than ours then that adds an additional cost, looking at the performance difference between hedged and unhedged versions of the same ETF this seems to add a 2% drag on performance from the sterling hedged against dollar version but compare ETFs yourself even if that is nor what you intend to buy.


It's not 2% now. The current GBP/USD 12-month fx swap is 173/174 pips or an implied yield differential of 1.37%. The US OIS curve is pricing substantial cuts over the next year, so the rate differential to the UK has tightened around 30bp in just the last month.


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