Currency hedged bond ETFs ?

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Astones
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Currency hedged bond ETFs ?

Post by Astones »

I was watching a Sharpe interview, and he came up with a sort of cryptical sentence when talking about bond funds his "perfect portfolio".

"The international bond fund is currency hedged. I don't know how I feel about it"

And he just left it there.......


I tried to do a little bit of research, Ben Felix made a video (Common sense investing) where he explains that according to the data there is not a definitive answer about what is better.

What are your thoughts on the subject ?
What is some good literature in which the pros and cons are clearly explained ?
secondopinion
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Re: Currency hedged bond ETFs ?

Post by secondopinion »

Astones wrote: Fri May 14, 2021 12:23 pm I was watching a Sharpe interview, and he came up with a sort of cryptical sentence when talking about bond funds his "perfect portfolio".

"The international bond fund is currency hedged. I don't know how I feel about it"

And he just left it there.......


I tried to do a little bit of research, Ben Felix made a video (Common sense investing) where he explains that according to the data there is not a definitive answer about what is better.

What are your thoughts on the subject ?
What is some good literature in which the pros and cons are clearly explained ?
I feel not much is gained with currency hedged bonds when one is worried about the dollar. I would want unhedged bonds personally. Yes, the volatility is higher; but I think we miss the point otherwise.
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Astones
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Re: Currency hedged bond ETFs ?

Post by Astones »

Agreed. Outside US there might be additional problems, but in principle unhedged seems to be the right way to go.
hi_there
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Re: Currency hedged bond ETFs ?

Post by hi_there »

Not sure what he means unless he elaborates on it. On one hand you won't get the diversification benefit of a global FX basket - bad? On the other hand, you don't have the FX exposure, so you are more directly invested in foreign credit - maybe good? So, it depends on your objective.
secondopinion
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Re: Currency hedged bond ETFs ?

Post by secondopinion »

hi_there wrote: Fri May 14, 2021 1:52 pm Not sure what he means unless he elaborates on it. On one hand you won't get the diversification benefit of a global FX basket - bad? On the other hand, you don't have the FX exposure, so you are more directly invested in foreign credit - maybe good? So, it depends on your objective.
Right, the foreign credit risk/return is the primary driver for the desire of USD-hedged foreign bond funds. If one is not concerned about the USD in comparison to other currencies, then it could be beneficial to just use the USD-hedge.

When it is unhedged, you get both the foreign credit risk/return and currency risk/return. When it is well diversified and good quality, then it should protect against USD devaluation, but it will also miss out on USD appreciation.

Take your pick. I pick unhedged bonds because I avoid making the bold decision to be USD exclusive with bonds. I do not hold them right now because the amount of funds toward bonds is not meaningful to justify it (I already have a bit of international stock which is not often hedged).
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Astones
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Re: Currency hedged bond ETFs ?

Post by Astones »

secondopinion wrote: Fri May 14, 2021 5:31 pm Take your pick. I pick unhedged bonds because I avoid making the bold decision to be USD exclusive with bonds. I do not hold them right now because the amount of funds toward bonds is not meaningful to justify it (I already have a bit of international stock which is not often hedged).
How is currency appreciation correlated with stock performance, usually ?
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Re: Currency hedged bond ETFs ?

Post by Karamatsu »

Depending on the currency and the duration, exchange rate fluctuations can swamp the return on foreign bonds over the course of a single day, so it seems to me that if what you want is the bond return and low volatility that bond funds are typically used to provide in a typical Boglehead portfolio, then it's better to use hedged bond funds; if what you want is to speculate on exchange rates or hedge against a possible fall in the dollar, then unhedged (government) bond funds might be one casual way to do that, but I suspect there are better options. Foreign equity index funds usually aren't hedged, for example, and then there is the whole world of derivatives and derivative-based ETFs that are pure plays on the currency.

I've always wanted a way to hedge the USD/JPY rate but have never found a way that didn't seem more risky than the exchange rate itself, so instead just split both my equity and bond allocations between the two.
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Re: Currency hedged bond ETFs ?

Post by OohLaLa »

I was actually looking into this question, because I am heavily invested in USD-based funds (equities + bonds), while I'm a Canadian citizen. Looking to hedge a certain portion (one account) to minimize the dependency on the foreign currency.

General idea:
Hedging Bonds = good, because currency risk represents significant or even major part of volatility (hedging means a more "pure" use of said bonds)
Hedging Equities = debatable/ variable, because currency risk does not account for major part of volatility

Here's an opinion article from Morningstar:
https://www.morningstar.com/articles/98 ... for-stocks

Here's an in-depth analysis by Vanguard:
https://www.vanguardcanada.ca/documents ... cision.pdf
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Re: Currency hedged bond ETFs ?

Post by watchnerd »

Astones wrote: Fri May 14, 2021 12:23 pm

What are your thoughts on the subject ?
What is some good literature in which the pros and cons are clearly explained ?
As part of my global allocation to stocks and bonds, I hold USD-hedged bonds.

Begrudgingly.

I would actually prefer to have an unhedged version of BNDW.

But...

The closest unhedged semi reasonable substitute, BWX, is only sovereign foreign Treasuries (no corp bonds) and it has an ER = .35.

The ER is particularly irksome in this low rate environment.

So, in short, I hold USD-hedged foreign bonds because I don't have the choice of a fund that offers what I really want, which would be:

-- Unhedged

--Sovereigns and corporates

--ER below .10
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Re: Currency hedged bond ETFs ?

Post by YRT70 »

Astones wrote: Fri May 14, 2021 12:23 pm I was watching a Sharpe interview, and he came up with a sort of cryptical sentence when talking about bond funds his "perfect portfolio".

"The international bond fund is currency hedged. I don't know how I feel about it"

And he just left it there.......


I tried to do a little bit of research, Ben Felix made a video (Common sense investing) where he explains that according to the data there is not a definitive answer about what is better.

What are your thoughts on the subject ?
What is some good literature in which the pros and cons are clearly explained ?
"For investors who choose to diversify their fixed income portfolios with holdings outside of the U.S., hedging currency exposure (also known as foreign exchange, or FX, exposure) on a systematic basis can help mitigate portfolio volatility in exchange for the market’s pricing of expected currency returns."

https://personal.vanguard.com/pdf/inter ... income.pdf
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Re: Currency hedged bond ETFs ?

Post by Anon9001 »

Most certainly yes if you are living in a EM country as interest rates and inflation are much lower in EURO,JPY and USD in comparison to your EM currency so you getting paid money for hedging where-as if you leave currency unhedged you are getting the currency return which tends to fluctuate widely but it is a good assumption to assume that long term it is 0% real return. This is not a big problem for stocks but for bonds this currency risk should be avoided as the volatility of the currency is much higher than the bond volatility whereas for stocks the opposite is true.
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Re: Currency hedged bond ETFs ?

Post by JackoC »

Astones wrote: Fri May 14, 2021 12:23 pm I was watching a Sharpe interview, and he came up with a sort of cryptical sentence when talking about bond funds his "perfect portfolio".

"The international bond fund is currency hedged. I don't know how I feel about it"

And he just left it there.......
I think it depends on whether 'international' means developed market or emerging market (or global ex-US but I don't think that's common with bond funds).

For emerging, which is where I have 'voluntary' foreign bond position, currency return is part of the idea. It's a risk asset, *not* a substitute for US treasuries or other US govt guaranteed debt, but part of the idea is eventual convergence of EM currency purchasing power, and the risk of EM currencies instead consistently losing purchasing power v USD in the long run is a somewhat different risk than the basket of risks in EM stocks, and more different still from the basket of risks in US stocks: diversification. FX hedging would defeat the basic purpose.

For developed markets, I'm not enthusiastic (have some currency hedged DM bond position via Vanguard Life Strategy Fund in kids' accounts) about it either way. In this case the bonds *are* a 'safe' asset, and the idea of such a fund IMO is mainly to diversify away from US government *credit* to the extent that's viewed necessary. The problem seems to me is if US government credit eventually comes into question in the market it would seem very likely to be accompanied by a big weakening of the USD v DM currencies, which you would not gain from in the hedged DM bond fund. OTOH taking unhedged DM currency risk assuming things muddle along as normal means quite a bit of FX noise* with no expected return, IMO (I believe EM currencies have a positive expected return at today's valuations but I don't think DM currencies do, others are free to differ). And, having the hedged DM bond fund just to diversify return (US treasury return v DM bond+FX hedge carry return) is not worth the trouble IMO.

*USD value of foreign currency bonds is very highly correlated to the FX rate; the USD value of foreign stocks has a much looser relationship to the value of the currency in which those stocks are quoted.
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Re: Currency hedged bond ETFs ?

Post by watchnerd »

JackoC wrote: Sat May 15, 2021 9:09 am
For emerging, which is where I have 'voluntary' foreign bond position, currency return is part of the idea. It's a risk asset
In the context of the Sharpe portfolio, all bonds are risk assets.
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Re: Currency hedged bond ETFs ?

Post by JackoC »

watchnerd wrote: Sat May 15, 2021 10:16 am
JackoC wrote: Sat May 15, 2021 9:09 am
For emerging, which is where I have 'voluntary' foreign bond position, currency return is part of the idea. It's a risk asset
In the context of the Sharpe portfolio, all bonds are risk assets.
OK but that strikes me as a bit theoretical. It's AFAIK pretty universally accepted to speak of X stock/Y bond under the assumption of very high credit quality (near 'riskless') for the 'bond' portion. And one of the big hang ups people here have about risky bonds IME is the assumption that whenever they are mentioned, somebody is tying to 'sell' a free lunch of substituting them for conventional 'riskless' bonds 1:1. In case of EM local, IMO their expected return is not that much different than US stocks at their now lofty valuations, but OTOH you can't count on them being much less risky either (perhaps slightly lower expected return and slightly lower risk depending how you define risk). Whereas FX hedged DM govt bonds would be a pretty close substitute for US govt bonds riskwise. That's the practical difference I'm referring to.
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Re: Currency hedged bond ETFs ?

Post by watchnerd »

JackoC wrote: Sat May 15, 2021 10:26 am
OK but that strikes me as a bit theoretical.
It is theoretical, but it makes sense in the context of the RISMAT series.

For safety, Sharpe says the risk portfolio should be coupled with a riskless asset, annuity, pension, or whatever, to provide basic income.

This is the approach you can see in my signature.

He describes the global market portfolio as an attempt to get the total efficient frontier.
As indicated earlier, we will focus much of our analysis of investment alternatives on two key
assets. The first, providing riskless real returns, was covered in Chapter 6. The second is a
portfolio of securities that provides uncertain future real returns. But not just any such
portfolio. Rather, we use a practical approximation of a theoretical construct termed the market
portfolio.

In a simple world, the market portfolio would include every publicly traded security, with each
held in proportion to the total amount outstanding. An investor could hold his or her version of
the market portfolio by purchasing x% of the outstanding shares of every traded stock and x%
of the outstanding number of bonds for every traded bond, where x is the ratio of his or her
invested wealth to the total value of the amounts invested by everyone.
https://web.stanford.edu/~wfsharpe/RISMAT/RISMAT-7.pdf
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Re: Currency hedged bond ETFs ?

Post by JackoC »

watchnerd wrote: Sat May 15, 2021 10:36 am
JackoC wrote: Sat May 15, 2021 10:26 am
OK but that strikes me as a bit theoretical.
It is theoretical, but it makes sense in the context of the RISMAT series.

For safety, Sharpe says the risk portfolio should be coupled with a riskless asset, annuity, pension, or whatever, to provide basic income.

This is the approach you can see in my signature.
Still not seeing how this is anything but a nitpick wrt to my point, but we should probably leave it there. I anyway will have nothing further to say. I believe my point was clear, and relevant, practically. EM and DM bonds are in distinctly different risk categories with latter a close substitute for US govt bonds, former not.
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Re: Currency hedged bond ETFs ?

Post by watchnerd »

JackoC wrote: Sat May 15, 2021 10:45 am
Still not seeing how this is anything but a nitpick wrt to my point, but we should probably leave it there. I anyway will have nothing further to say. I believe my point was clear, and relevant, practically. EM and DM bonds are in distinctly different risk categories with latter a close substitute for US govt bonds, former not.
It's not a nitpick, it's a clarification of the framing of the role of bonds.

I don't hold foreign bonds as the risk free asset, nor do I expect them to be.

IMHO, if the objective of holding bonds is simply to hold the risk free assets, I wouldn't include foreign bonds in that bucket, or even corporate USD denominated.

If optimizing for risk free, and you're a USA investor, Treasuries (in nominal and TIPS flavors) should be the asset of choice.

So, yes, your holding of EM bonds is a risk asset, just like all foreign bonds and USD corporates.

I don't think this is in disagreement with your POV.
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Astones
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Re: Currency hedged bond ETFs ?

Post by Astones »

watchnerd wrote: Sat May 15, 2021 12:00 pm It's not a nitpick, it's a clarification of the framing of the role of bonds.

I don't hold foreign bonds as the risk free asset, nor do I expect them to be.

IMHO, if the objective of holding bonds is simply to hold the risk free assets, I wouldn't include foreign bonds in that bucket, or even corporate USD denominated.

If optimizing for risk free, and you're a USA investor, Treasuries (in nominal and TIPS flavors) should be the asset of choice.

So, yes, your holding of EM bonds is a risk asset, just like all foreign bonds and USD corporates.

I don't think this is in disagreement with your POV.
Sooner or later I will have to go back to Europe.
Would you suggest to avoid foreign bonds altogether, buy a bunch of low yield European governments bonds and keep the risk on the equity side ?

It's an option I'm considering. I'm at the beginning of my investment career, so we're talking about no more than 10% of my portfolio after all.
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Re: Currency hedged bond ETFs ?

Post by watchnerd »

Astones wrote: Sat May 15, 2021 12:15 pm
Sooner or later I will have to go back to Europe.
Would you suggest to avoid foreign bonds altogether, buy a bunch of low yield European governments bonds and keep the risk on the equity side ?

It's an option I'm considering. I'm at the beginning of my investment career, so we're talking about no more than 10% of my portfolio after all.

How old are you now and how far out in the future will you go back to Europe?

If you're young enough, maybe just avoid the issue entirely by avoiding bonds entirely.
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Astones
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Re: Currency hedged bond ETFs ?

Post by Astones »

watchnerd wrote: Sat May 15, 2021 12:20 pm How old are you now and how far out in the future will you go back to Europe?

If you're young enough, maybe just avoid the issue entirely by avoiding bonds entirely.
I'm 30 and I'll likely go back in the close future, like end of year.

I've seen people suggesting to avoid bonds, indeed. I felt like I wouldn't mind a little bit of diversification among asset classes, even with small weight.

90% is going to whatever good alternative I find to the American VT, and that problem is solved. Then, either I make it 100% and I dodge the issue completely, or I need to determine what else I could do with the remaining 10 %.
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Re: Currency hedged bond ETFs ?

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Astones wrote: Sat May 15, 2021 12:26 pm

90% is going to whatever good alternative I find to the American VT, and that problem is solved. Then, either I make it 100% and I dodge the issue completely, or I need to determine what else I could do with the remaining 10 %.
In 1 year, inflation isn't a giant concern.

Hold 5% in USD cash, 5% in UDN.

Now you've avoided interest rate risk and hedged currency risk.
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