Currency-Hedged International Funds? Why?

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nobsinvestor
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Currency-Hedged International Funds? Why?

Post by nobsinvestor »

I've been seeing all these articles lately in the financial press (which is useless noise, I know) about currency hedged international funds. I don't get it.

Doesn't that take away the whole point of international stocks providing portfolio diversification, in that they provide natural currency diversification? I for one wouldn't want Vanguard Total International to hedge currency!
dkturner
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Re: Currency-Hedged International Funds? Why?

Post by dkturner »

nobsinvestor wrote:I've been seeing all these articles lately in the financial press (which is useless noise, I know) about currency hedged international funds. I don't get it.

Doesn't that take away the whole point of international stocks providing portfolio diversification, in that they provide natural currency diversification? I for one wouldn't want Vanguard Total International to hedge currency!
Funny, Jack Bogle dislikes international investing largely because of the currency risk. He seemingly can live with slightly lower returns from international stocks but he can't handle the currency swings from an unhedged international portfolio. When he ran the Vanguard Group I wonder if the Vanguard international funds hedged their currency risk?
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nisiprius
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Re: Currency-Hedged International Funds? Why?

Post by nisiprius »

You have to say whether or not you want to have, basically, a FOREX allocation in your portfolio, and, if so, why. The conventional wisdom is that currency has an expected long-term real return of zero.

The usual claim for a diversification benefit from international funds is that they provide diversification across businesses, across national economies, and national economic policies.

The role of currency is always debated. And one of the more controversial points is this. Currency movements definitely adds risk. Most authorities say they have zero long-term real return. If so, is it actually possible for it to improve a portfolio through low correlation?
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nobsinvestor
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Re: Currency-Hedged International Funds? Why?

Post by nobsinvestor »

nisiprius wrote:You have to say whether or not you want to have, basically, a FOREX allocation in your portfolio, and, if so, why. The conventional wisdom is that currency has an expected long-term real return of zero.

The usual claim for a diversification benefit from international funds is that they provide diversification across businesses, across national economies, and national economic policies.

The role of currency is always debated. And one of the more controversial points is this. Currency movements definitely adds risk. Most authorities say they have zero long-term real return. If so, is it actually possible for it to improve a portfolio through low correlation?
I understand the long-term real return of currency is zero, and that makes sense. But would the FOREX fluctuations not be of use if the dollar declined to an all-time low and stayed that way for 30 years, or forever, or something catastrophic happened to the dollar (however unlikely)? It would seem a useful diversifier then. By hedging in dollars it does seem to place an awfully big bet on the dollar.

Nobody has a crystal ball of course.

Let me ask you this also- if Vanguard offered an identical total international stock fund at the same cost but it was hedged, would you buy the hedged or the unhedged fund?
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Re: Currency-Hedged International Funds? Why?

Post by Leeraar »

I've had a reasonable (unhedged) allocation to international stocks for over 30 years. I've been happy, but I don't have much of a theory. I see it as diversification that has benefited me in both directions, USD relatively up or down.

I am not sure that currency is a zero-sum game. There have been numerous currency collapses.

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Re: Currency-Hedged International Funds? Why?

Post by Phineas J. Whoopee »

nobsinvestor wrote:...
Let me ask you this also- if Vanguard offered an identical total international stock fund at the same cost but it was hedged, would you buy the hedged or the unhedged fund?
I'm not nisi, but I personally would buy, in fact have bought, the unhedged fund. Hedged international equity funds are readily available to those who wish to own them, if not at as low a cost or as well indexed as Vanguard's Total International.

The currency movements have been notable, but over time have been swamped out by the equity returns.

If I were to buy an international bond fund, which right now I don't think would meaningfully improve my portfolio but future data or events could convince me otherwise, I'd want it to be currency hedged, because currency movements can easily swamp out fixed income returns.

One might argue it makes no difference, because X% of my portfolio is a broad forex position either way, and to that assertion I would have no good response.

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Re: Currency-Hedged International Funds? Why?

Post by Buysider »

I've been seeing all these articles lately in the financial press (which is useless noise, I know) about currency hedged international funds.
US markets and the US dollar have been strong recently. The press likes reporting about investments that have recently done well. Citi came out with an oil prediction of $20/bbl. Who knows what they'll say next week ...
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Re: Currency-Hedged International Funds? Why?

Post by avenger »

I own Vanguard's Total International Bond Index fund and the fund hedges currency.
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Re: Currency-Hedged International Funds? Why?

Post by Valuethinker »

avenger wrote:I own Vanguard's Total International Bond Index fund and the fund hedges currency.
Generally it is held that since the currency volatility will exceed the yield to maturity of the bond, it's better to hedge bond currency exposure. Otherwise you risk taking on a lot of volatility with no compensating return. Since a bond pays out in a defined currency, there's a correlation between the returns you get and the performance.

Stocks are a bit different. Their inherent volatility is much greater. And the payout of a stock is not limited to one currency, in the sense that Apple is a USD company, but has sales and operations (which impact its performance and thus returns to shareholders) all over the world.

Also equity performance and currency performance are not correlated-- or rather I think the correlation is empirically slightly negative (devaluation can be good for stock markets). Thus there is a (small) diversification gain from the lack of correlation between the 2 factors.

Theoretically you should match your currency of consumption to your assets. If 90% of your future consumption is in USD, that's what your assets should be. In practice that's very hard to predict (what will be my consumption of USD products and services in 2035 say, given I live in the UK?).

So we use rules of thumb. One of which is that bonds are generally hedged against currency movements, and we do not incur the additional costs etc. of hedging our equities.
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Re: Currency-Hedged International Funds? Why?

Post by danieljquirk »

I think I agree with Nisiprius on this issue.

Vanguard hedges international bonds because currency adds volatility and no expected return. Presumably it can hedge pretty cheaply, or it wouldn't do this.

Vanguard does not hedge international stocks because umm.....ummmm..... ummmm?

Why doesn't the same logic hold for equities? When you look at the underperformance of VXUS vs. VTI over the last several years, it is rather astounding--(60% or so over 5 and 10 years). A good bit of it has to do with the strengthening of the dollar.

If you are a US based consumer and investor, why would you want to be invested in anything other than US dollars?

Is there a correlation benefit? Is there any logic/predictability to the strength of the US dollar and the performance of US equities vs. international. It seems that a strengthening dollar and outperformance of US equities are correlated (i.e. 2009-2015, 1994-1999). Is the randomness of currency actually a good thing because it promotes diversification/correlation benefits?

Does this logic mean that slicer/dicers would be better off adding a random currency overlay to small value or REITs or whatever?
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