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hedged vs unhedged for international equities

Discussion in 'Exchange Traded Funds (ETF)' started by venger0, 17th Apr, 2008.

  1. venger0

    venger0 Active Member

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    hello all,

    been thinking of whether or not currency hedging is something that is worth paying for when investing in international markets (indexed).

    my current portfolio includes ishares for foreign exposure (IOO for S&P global 100 and IEM for emerging market index). non of the ishares are hedged.
    currency risk is a concern for me.

    proposed solution: divide my IOO portion in halves and invest one half in a hedged fund or ETF. the international portion will then look like this: 40% hedged int. index fund, 40% unhedged fund (IOO), 20% emerging market (also unhedged)

    idea is that the above will lower volatility without (hopefully) lowering the return of the portfolio.

    what do you reckon? esp. those are using ishares which make up more than 20% of their portfolio... are you concerned about currency risk? if no, why not? would love to hear your thoughts....

    FYI, amongst retail options, i've only found one index fund that offers hedging - the Vanguard fund.
     
  2. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    It may be worth examining the Platinum International versus the Platinum Unhedged funds to see what impact hedging may (or may not) have. These aren't index funds - but they are funds which both have very similar strategies (indeed the Unhedged Fund is basically a version of the International Fund - not identical, but similar in goals). I just bring them up as possible examples.

    Just a suggestion.

    I don't hold any index funds myself - so I can't comment on that side of things.

    I will mention that currency hedging seems to be a very difficult topic - the experts all seem to disagree on the best approach.

    My personal (non-expert) opinion is that hedging is more trouble than it is worth - the costs outweigh the benefits. I'm sure some people will disagree - and I'd be interested to hear their reasoning.
     
  3. Tropo

    Tropo Well-Known Member

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    Some players are comfortable with a full currency hedge others consider hedging as useless and costly.
    First one must determine whether the hedge is passive or active.
    Passive is designed to ’insulate’ the outstanding position from the exchange fluctuation (realize a profit/loss as close to zero as possible)
    Active is designed to enhance the profit of the original position by using stop-loss in spot & forward markets and currency options.

    To hedge or not to hedge (that is a question ;)) depends on the time frame, volatility of currency, the market view on the specific currency and the level of risk each investor/trader/MF is willing to take.
     
  4. venger0

    venger0 Active Member

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    Hey Tropo - thanks for your thoughts :)

    Regarding your points:
    - 'depends on the time frame' - yes, but how do you think timeframe affects the decision? lets say my timeframe is 25 years. Would it then mean that hedging becomes less of an issue? (eg, because historical data shows that currency tend to return to mean, etc)

    - 'volatility of currency' - does hedging or non hedging actually reduce volatility?

    - 'level of risk' - which would reduce level of 'risk'? hedging or non-hedging or a combo of both?

    the stuff that i've read from posts in this forum and others have certainly shown that there is no clear cut answer (as far as i can tell - but this is probably due to my lack of understanding - stuff like this gives me a headache :D).

    for a case in point:

    'John Smith is:
    (A) a passive index investor with a timeframe of 25 years+.
    (B) John would be comfortable with a 50% drop in value of his international funds.'

    For (A), should John hedge all, hedge none or do a bit of both? why?
    For (B), does hedging or not hedging have any affect?

    not sure if there is an optimal/correct path - ie, John might have to do a bit both (say 50% hedged, 50% unhedged) to cover all bets.



     
  5. Tropo

    Tropo Well-Known Member

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    - 'depends on the time frame' - yes, but how do you think timeframe affects the decision

    The expected time frame of the position/investment to maturity is an important factor in deciding whether to hedge.
    Some players are reluctant to hedge the currency side of investment held for 3 or more years, but they may be eager to hedge short term investments.
    Always consider time as a hedging factor along with a specific currency.

    - 'volatility of currency' - does hedging or non hedging actually reduce volatility?

    No....Some currency are more volatile than others.
    The main benefit of a full hedge would be in the form of a reduction in portfolio volatility.

    - 'level of risk' - which would reduce level of 'risk'? hedging or non-hedging or a combo of both?

    It all comes down to an accurate view of the market, level of knowledge, and risk you willing to take.
    In some cases hedging may increase/decrease a risk.

    Re: ‘John Smith’ .
    To hedge or not to hedge = to be or not to be .... that is the question.;)

    I can not attach the link...so go to google, type: currency hedging and click on Global Currency Hedging
     
    Last edited by a moderator: 18th Apr, 2008
  6. venger0

    venger0 Active Member

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    thanks Tropo :)

    i also found a few other articles on the topic. In particular, over at efficientfrontier.com by William Bernstein, there's an old paper detailing his reasoning and conclusions regarding hedged vs unhedged.
    His view? doesn't see a real need to hedge...

    For a local viewpoint, Travis Morien's faq has another take - take a bet each way (50% hedged, 50% unhedged)...


    anyway, hope it helps others too...