Is it too late to hedge your offshore investments?
The Aussie dollar’s pandemic surge, from a low of 57 cents on March 23 to over 71 US cents last week, has driven a flood of interest in hedging, that is, eliminating the currency risk from overseas exposures in shares, fixed interest and infrastructure. Let’s look at three questions:
- Should I hedge?
- How can I hedge?
- Is it too late?
Should I hedge?
There is no right or wrong answer to this question and the evidence is mixed.
Starting with the currency first, the chart below from the Reserve Bank shows the Australian dollar against the US dollar (red), Yen (orange) and Euro (blue) over the last 36 years. The following observations could be drawn:
a) The Aussie dollar appears to be in a long term down trend. This suggests that hedged exposures aren’t needed;
b) The time spent below 60 US cents has been very brief (5occasions, including March 2020). Hedging in the50s/60s might make sense;
c) It also hasn’t had too many occasions over 80 US cents but did spend 5 years above this level from 2009 to 2014. Perhaps this is an upside level where hedges are taken off.
Next, the performance data. According to Chant West, unhedged international share exposures have beaten hedged international share exposures over each of the following periods: 1 year, 3 years, 5 years, 7 years, 10 years and 15 years.
This data is to 30 June 2020 and is based on the standard international benchmarks. Over 15 years, the gap has narrowed to a difference of 0.7% pa. This reflects in part that hedging is not costless, and further, that the Aussie dollar was lower on 30 June 2020 than it was on 30 June 2005. If the period was 20 years, it might marginally favour a hedged strategy.
Finally, several active equity managers who don’t hedge argue that currencies tend to even out over time. There is also a view that hedging actually leads to a higher volatility of returns. This is because the Aussie dollar is a “risk on” currency and gets sold off when global risk appetite is weak and share markets are falling (as happened in February), and gets purchased and rises when the risk appetite improves and global share markets rise (as has been happening from March 23). Somewhat perversely, hedging increases risk rather than reduces it.
How can I hedge?
Unless you have millions of dollars to invest and arrangements in place with your bank, practically speaking, you can’t hedge your currency exposures. However, you can invest in currency hedged products (funds) and depending on the product, switch from an unhedged version to a currency hedged version (or vice versa).
Many of the index tracking exchange traded funds (ETFs) offer currency hedged versions. For example, the biggest international shares ETF listed on the ASX, iShares IVV (which tracks the US S&P 500 index) offers a currency hedged version called IHVV. If you hold IVV and want the currency hedged version, you will need to sell IVV and buy IHVV. Apart from marginally higher management fees in IHVV (to help cover the costs of hedging), the products are otherwise identical.
Picking up on the demand for ‘hedged’ product, ETF provider Betashares launched three new currency hedged funds last week:
- HNDQ, which tracks the NASDAQ 100
- HQLT, which tracks an index of 150 global companies ranked by ‘quality’, and
- HETH, which tracks a NASDAQ index of future global sustainability leaders.
Of the active managers, Magellan offers a currency hedged version of its core Magellan Global Equities Fund, MGE. This trades under the ASX code of MHG.
The table below shows unhedged and currency hedged versions for the major ETFs and ASX quoted active managed funds.
In the fixed interest area, several ETF providers offer as standard hedged products (which give access to credit and volatility risk, but not foreign exchange risk). VIF (Vanguard International Fixed Interest Index Fund) and VCF (Vanguard International Credit Securities Index Fund) are automatically hedged back into Australian dollars. iShares also has two hedged ETFS: IHCB (iShares Core Global Corporate Bond) and IHHY (iShares Global High Yield Bond).
Is it too late to hedge?
My sense is that investors sometimes make too big an issue of currency risk and that it goes with the territory of investing offshore. You can’t eliminate price risk on the security, so why would you want to eliminate currency risk?
The evidence to hedge is not strong, as bourne out by the performance data and the behaviour of the Aussie dollar when “crises” hit. Further, I think the long term downtrend is in place.
Bottom line: I am a “hedge in the 60s” and “take the hedge off in the 80s” type of investor. At 71c, I am a touch ambivalent.
Interestingly, Michael Knox, the Chief Economist at Morgans, is very bullish on the Aussie dollar. He thinks that 2020 is shaping up as a replay of 2010 when the US Government deficit blew out and borrowing (the issue of US Treasury bonds) surged. This led to a weakening in the US dollar and an increase in commodity prices (which are denominated in US dollars). To quote Michael: “I would be surprised if the Aussie dollar didn’t get into the 80s”. You can watch Peter’s interview with Michael on tonight’s episode of SwitzerTV: Investing at 8pm on our Youtube channel 'Switzer Financial Group'.
Taking Michael’s view into account, I don’t think you’re too late. But there will come a point where the additional costs of hedging work against the long term returns of running a hedged portfolio.