Need advice on currency hedging in Europe. Not in Eurozone.

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mrekvy491
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Joined: Wed Jul 29, 2020 10:43 am

Need advice on currency hedging in Europe. Not in Eurozone.

Post by mrekvy491 » Sat Aug 01, 2020 8:15 am

Hi, I am looking for advice on how to take advantage of the currency headged world stock portfolios. I am not so sure if I am being too naive, or misunderstanding the currency risk.

1. I am an non-EU expat living in a European country that does not use Euro. My wife and I are trying to put as much as possible into our stock portfolio, as we are in our mid 30s so we have more time to benefit from the compounding.

We have an emergency fund that covers our expenses for 6 months, and have a couple of real estate properties (One in the current country of residence, the other in my home country) with our primary residence free and clear. So we want to go for a 100% world stock portfolio for a while, before increasing the global bond allocation. I am working for a government-run institution, and have a relatively stable job.

2. We are buying 'Vanguard FTSE All-World UCITS ETF (USD) Accumulating' (VWCE, TER 0.22%), and we want to maintain the 100% allocation on world stock portfolio for the next 10 years. However, I am also worried that I may not be able to tolerate the swings in the equities when the volatility is too high.

3. So I am thinking of purchasing EUR or CHF hedged world stock ETFs such as
UBS ETF (IE) MSCI ACWI SF UCITS ETF (hedged to EUR) A-acc (ACWIE, TER 0.19%)
UBS ETF (IE) MSCI ACWI SF UCITS ETF (hedged to CHF) A-acc (ACWIS, TER 0.19%)

when either EUR and CHF is relatively cheap, with a cap of 30% of our total portfolio. Both are synthetic, but hedged at a reasonable price.

4. I think there could be three benefits in this approach.

A. This will reduce the concentration risk on USD. VWCE has 55% allocation in US market, but we live in Europe. Purchasing ACWIE or ACWIS should increase our exposure to other European currencies while lowering our exposure to USD.

B. Though this might sound strange, I think this may provide us some 'psychological ballast' while holding a high ratio of the world stock portfolio. This approach should also reduce our exposure to EM currencies and 'risk-on' currencies like AUD. As EUR and CHF are considered to be 'safer' than our local currency, and we 'count' the performance of our portfolio in our local currency, the value of these currencies should go up when the market is in a downturn, offsetting the loss of our portfolio.

We observed this happening to our portfolio in the last few months. In our case, the performance of our current VWCE portfolio depended heavily on the exchange rate of the USD to our local currency. The value of our local currency went down in March (~20%) offsetting the loss in equities. It was a bit comforting to see that the loss was somewhat limited.

I am thinking that I hope this should help us hold stocks, so we can get the most out of the growth of the market in the next 15~20 years. We only want to hold up to 20~30% of bonds maximum even when we near our retirement.

5. I understand that this won't provide ant proteciton against our local currency being appreciated in the long term. But I am willing to take a bet if this could help us maintain a high equity allocation. We get capital gains tax exempted if we hold equities for more than 3 years, so we could even implement a bit of 'currency timing' element into play. Buying CHF or EUR when they are cheap, selling the hedged fund when it is high, while maintaining our market cap weighted world stock allocation. I am okay with the idea of being at the mercy of the world stock market, but no at the hands of the volatile exchange rates. I feel way more comfortable in having some kind of control over the swings in the currencies. May not be so benefitial, but could at least behaviorally better. I may invest more on local real estates to minimize our currency risk, in this approach benefits us from the swings in the exchange rates in the short term.


However, I am not so sure if I am understanding this correctly. Is this a legitimate approach? Would this actually provide the benefits I think could give us? I would appreciate your advice, or comments. I will be happy to learn more about this, so I understand the risks and benefits better.

Rosales
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Joined: Thu Apr 30, 2020 8:43 pm

Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by Rosales » Sat Aug 01, 2020 11:38 am

Which country do you live in? People here normally don't hedge their equity exposure.
VWRA & chill | Retired @28 y.o.

Topic Author
mrekvy491
Posts: 14
Joined: Wed Jul 29, 2020 10:43 am

Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by mrekvy491 » Sat Aug 01, 2020 2:10 pm

Rosales wrote:
Sat Aug 01, 2020 11:38 am
Which country do you live in? People here normally don't hedge their equity exposure.
Thanks for weighing in. I live in Czech Republic and my income and spendings are in Czech Koruna (CZK).

I also think that it is a consensus here. If I understand correctly, usually the flucutations in currencies average out in the long term and hedging is unlikely to make a meaningful difference considering the cost.

But I have been still thinking about this, as my goal is not owning a hedged equity portfolio entirely. Rather, it would be to increase my currency exposure to EUR or CHF while holding the same world stock allocations of VWCE. I could own something like 70% VWCE, and 30% of ACWIE/ACWIS. My USD exposure would change from 55% to 38%, my EUR exposure from around 10% to more than 30%, other currencies from around 20% to 10%. I am not so sure if this as a strategy could be beneficial from someone like me who wants less exposure to the more 'risky' currencies.

I believe I won't be able to get protection from CZK appreciating long term anyway.

Rosales
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Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by Rosales » Sat Aug 01, 2020 3:19 pm

I would just keep things simple and go 100% VWCE with equities and avoid synthetic stuff. Just chill and accept what the market gives you.
VWRA & chill | Retired @28 y.o.

glorat
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Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by glorat » Sat Aug 01, 2020 10:31 pm

Rosales wrote:
Sat Aug 01, 2020 3:19 pm
I would just keep things simple and go 100% VWCE with equities and avoid synthetic stuff. Just chill and accept what the market gives you.
+1

OP - you're mixing up equity exposure and currency exposure. They are far far from as linked as you might think. I won't get into a long theoretical speech on this unless you want one. In simplified terms, if you're exposed to global equities, you neither have nor want control over the currency exposure in any of the ways you are talking about.

I like Rosales's comment - just chill and accept what the market gives you.

Topic Author
mrekvy491
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Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by mrekvy491 » Sun Aug 02, 2020 4:51 am

@glorat: Thanks for your thoughts. But could you elaborate a bit more? I am now guessing it may be because the currency hedged funds track the index denominated in USD. Then it would merely 'correct' the differnce between USD and EUR/CHF, not reducing any exposure to other currencies. Not sure if this is what you meant If not, I would be happy to learn more about how the currency hedging actually works.

If my hunch is right, I will surely be sticking to VWCE alone as you and @Rosales suggested. Although holding a EUR/CHF hedged version may decrease my exposure to USD, probably won't make a huge difference.

sean.mcgrath
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Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by sean.mcgrath » Sun Aug 02, 2020 5:52 am

Hi mrekvy,

Fyi, there was a similar question recently that you might want to browse.

The psychological part I can't speak to -- I think that's pretty individual. I do recognize a concern about the USD being overvalued, however. My general belief is that PPP is a real limiter on currency swings, and my experience is that over time the USD/EUR rate averages out to the PPP rate.

Using the Big Mac index, it can be quantified. Even with the latest rise in the Euro, the USD is ~15% overvalued vs. the Euro (and 30% vs. the Koruna :shock: ). The swings can be enormous, as the Euro was 50% overvalued in 2008, and is now 15% undervalued.

I personally try to make some accommodation for limiting USD currency risk over my total portfolio. I have property in Europe, underweight US equities, and have bonds in Euro. My last calculation was that I have reduced the "risk" of reversion to PPP from 16% to 7%. I decided that was ok for me.

If you are heavy in equities (I am as well), the traditional advice of bonds in local currency is insufficient. I have not done it, but the currency hedging for equities could definitely make sense.

p.s. I guess if you really believe the Koruna is 30% undervalued, you should be piling into local real estate. :beer

Storamin
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Location: Düsseldorf, Germany

Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by Storamin » Sun Aug 02, 2020 6:37 am

VWCE has approx 55% of holdings in the US, including companies like Google, Apple, Microsoft. Those US companies operate all around the world and in many different currencies. 55% of holdings in the US does not equate to 55% exposure to the USD. Take the German DAX for example - German companies on the DAX only earn 20% of their revenue in Germany - if you bought only "German DAX" companies, your exposure to ex-Germany is approximately 80%.

I wouldn't bother getting any currency hedged ETFs. To me it is the exact opposite of diversification. Both the CZK and CHF were pegged to the EUR in early/mid 2010's anyways. Who knows, perhaps that comes back.

This has been widely covered in other posts - do a search for currency hedging.

Saying you want 100% equity while also saying you don't want the volatility is the most contradictory sentence I have seen in a while.

Do whatever you want to do to give yourself whatever 'psychological ballast' you need.

Topic Author
mrekvy491
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Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by mrekvy491 » Sun Aug 02, 2020 7:22 am

Storamin wrote:
Sun Aug 02, 2020 6:37 am
VWCE has approx 55% of holdings in the US, including companies like Google, Apple, Microsoft. Those US companies operate all around the world and in many different currencies. 55% of holdings in the US does not equate to 55% exposure to the USD. Take the German DAX for example - German companies on the DAX only earn 20% of their revenue in Germany - if you bought only "German DAX" companies, your exposure to ex-Germany is approximately 80%.

I wouldn't bother getting any currency hedged ETFs. To me it is the exact opposite of diversification. Both the CZK and CHF were pegged to the EUR in early/mid 2010's anyways. Who knows, perhaps that comes back.

This has been widely covered in other posts - do a search for currency hedging.

Saying you want 100% equity while also saying you don't want the volatility is the most contradictory sentence I have seen in a while.

Do whatever you want to do to give yourself whatever 'psychological ballast' you need.
@Storamin, thanks for your thoughts. I have to admit that I have read some of the discussions, but need more time to fully digest the information. I will continue doing that as I learn more from this forum.

I have thought about the argument that most of the revenues of US companies come from foreign countries. But I think it could work that way if all stocks are 'fairly priced' according to the revenue/earnings they make (in USD). Which I feel is not the case in the world growth stocks are dominating. I am not so sure if the extent of capital gains in the US stock markets reflect the overseas revenues in the 'fair' way. I hope I am mistaken. It will make it a lot easier for me to stick to 100% VWCE.

I also understand my stance may seem contradictory. But the reason I am buying into 100% VWCE strategy is that I know I am actually buying the idea that I am investing in the world market and the growth that 'capitalism' provides. So I can endure the downturns. But seeing my investment value swing and years of growth in FTSE-all world index being taken away just because values of few currencies swing 'feels somewhat unfair'. I guess am looking for something that can convince myself into believing that I can do much more than I think with the gains. I probably will hold 100% VWCE for now, but will keep thinking about this as I also see some pros in hedging.
Last edited by mrekvy491 on Sun Aug 02, 2020 1:29 pm, edited 10 times in total.

Topic Author
mrekvy491
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Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by mrekvy491 » Sun Aug 02, 2020 7:32 am

sean.mcgrath wrote:
Sun Aug 02, 2020 5:52 am
Hi mrekvy,

Fyi, there was a similar question recently that you might want to browse.

The psychological part I can't speak to -- I think that's pretty individual. I do recognize a concern about the USD being overvalued, however. My general belief is that PPP is a real limiter on currency swings, and my experience is that over time the USD/EUR rate averages out to the PPP rate.

Using the Big Mac index, it can be quantified. Even with the latest rise in the Euro, the USD is ~15% overvalued vs. the Euro (and 30% vs. the Koruna :shock: ). The swings can be enormous, as the Euro was 50% overvalued in 2008, and is now 15% undervalued.

I personally try to make some accommodation for limiting USD currency risk over my total portfolio. I have property in Europe, underweight US equities, and have bonds in Euro. My last calculation was that I have reduced the "risk" of reversion to PPP from 16% to 7%. I decided that was ok for me.

If you are heavy in equities (I am as well), the traditional advice of bonds in local currency is insufficient. I have not done it, but the currency hedging for equities could definitely make sense.

p.s. I guess if you really believe the Koruna is 30% undervalued, you should be piling into local real estate. :beer
@sean.mcgrath The first time I am seeing the BigMac index, and it does scare me! We also have our local property for exactly the same reason. Oh, maybe this is exaclty why so many expats here just end up hoarding properties here :)

sean.mcgrath
Posts: 462
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Location: US in NL

Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by sean.mcgrath » Sun Aug 02, 2020 8:32 am

mrekvy491 wrote:
Sun Aug 02, 2020 7:32 am
@sean.mcgrath The first time I am seeing the BigMac index, and it does scare me! We also have our local property for exactly the same reason. Oh, maybe this is exaclty why so many expats here just end up hoarding properties here :)
I have had two experiences with currency shifts. I was hitchhiking in France in 1986, with all of my money in USD. During the year I watched the value of my (very limited) money drop 30%. It made a big difference to what I was able to afford during the trip. The other was nicer: in 2008 we took a flight to the US for Christmas, and spent the entire week looking at vacation houses. Due to the drop in USD and the housing crises, we spent half what we would have spent a few years earlier to buy a house. I do believe people in multiple currency zones should be at least aware of PPP rates. For me the value is that you can calculate your exposure based on your currency moving to parity. "Your currency" is the one in which you plan to consume your investment.

We lived in Germany in 2000 and had Polish friends who were investing all their money in property back in Poland (as it just joined the EU). My son was studying in Greece during their crisis, and I was looking at apartment prices. In both cases I passed, even though it was pretty clear that there was real opportunity. I felt that since I didn't know the language/laws/culture, it was not the opportunity for me.

Topic Author
mrekvy491
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Joined: Wed Jul 29, 2020 10:43 am

Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by mrekvy491 » Sun Aug 02, 2020 9:07 am

sean.mcgrath wrote:
Sun Aug 02, 2020 8:32 am
mrekvy491 wrote:
Sun Aug 02, 2020 7:32 am
@sean.mcgrath The first time I am seeing the BigMac index, and it does scare me! We also have our local property for exactly the same reason. Oh, maybe this is exaclty why so many expats here just end up hoarding properties here :)
I have had two experiences with currency shifts. I was hitchhiking in France in 1986, with all of my money in USD. During the year I watched the value of my (very limited) money drop 30%. It made a big difference to what I was able to afford during the trip. The other was nicer: in 2008 we took a flight to the US for Christmas, and spent the entire week looking at vacation houses. Due to the drop in USD and the housing crises, we spent half what we would have spent a few years earlier to buy a house. I do believe people in multiple currency zones should be at least aware of PPP rates. For me the value is that you can calculate your exposure based on your currency moving to parity. "Your currency" is the one in which you plan to consume your investment.

We lived in Germany in 2000 and had Polish friends who were investing all their money in property back in Poland (as it just joined the EU). My son was studying in Greece during their crisis, and I was looking at apartment prices. In both cases I passed, even though it was pretty clear that there was real opportunity. I felt that since I didn't know the language/laws/culture, it was not the opportunity for me.
I also had a smiliar experience. I lived in Britain during the Asian financial crisis and our family's money (KRW) got devalued. The value halved over a few months, and many families just had to leave the country without finishing their school programs. It recovered to certain extent but I remember my dream being 'eating out' at a local McDonald's at least once, for years. Probably why I have this fear of huge currency swings.

I will do what you suggested for the 'PPP reality check' in the previous post. It will make me feel much better if I at least learn more about it. Maybe I could also consider hedging in EUR at one point.

sean.mcgrath
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Location: US in NL

Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by sean.mcgrath » Sun Aug 02, 2020 9:26 am

What do you think your retirement currency will be? Likely in Europe, or South Korea?

Topic Author
mrekvy491
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Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by mrekvy491 » Sun Aug 02, 2020 9:34 am

sean.mcgrath wrote:
Sun Aug 02, 2020 9:26 am
What do you think your retirement currency will be? Likely in Europe, or South Korea?
Hopefully it will be CZK. So maybe there is a case for EUR as a currency. Although part of me says that we could move somewhere else if CZK appreciates so much :happy

sean.mcgrath
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Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by sean.mcgrath » Sun Aug 02, 2020 9:46 am

mrekvy491 wrote:
Sun Aug 02, 2020 9:34 am
sean.mcgrath wrote:
Sun Aug 02, 2020 9:26 am
What do you think your retirement currency will be? Likely in Europe, or South Korea?
Hopefully it will be CZK. Maybe there is a case for EUR, although part of me says that we could move somewhere else if CZK appreciates so much :happy
If it appreciates while you are still reasonably early accumulating, that is not a bad thing. It means your salary will let you buy more assets.

Property could make sense if you are the kind of person to manage it. I think EUR hedged equities are also an option, although I do not really understand / have not looked into them. You could also split US and non-US ETFs, and overweight non-US (although this is under-weighting a geography as well as a currency).

Topic Author
mrekvy491
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Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by mrekvy491 » Sun Aug 02, 2020 3:46 pm

sean.mcgrath wrote:
Sun Aug 02, 2020 9:46 am
mrekvy491 wrote:
Sun Aug 02, 2020 9:34 am
sean.mcgrath wrote:
Sun Aug 02, 2020 9:26 am
What do you think your retirement currency will be? Likely in Europe, or South Korea?
Hopefully it will be CZK. Maybe there is a case for EUR, although part of me says that we could move somewhere else if CZK appreciates so much :happy
If it appreciates while you are still reasonably early accumulating, that is not a bad thing. It means your salary will let you buy more assets.

Property could make sense if you are the kind of person to manage it. I think EUR hedged equities are also an option, although I do not really understand / have not looked into them. You could also split US and non-US ETFs, and overweight non-US (although this is under-weighting a geography as well as a currency).
From what I read in this thread, I don't think I found a reason that I should not buy a EUR hedged fund. The hedged fund is synthetic but I read somewhere in this forum, that it is not as dangerous as one may think with new regulations in place. Will do more research but it could be worth a try if this is the case. Maybe I could have 20-30% of the EUR hedged version so the level of USD influence is more limited. I suppose I could also buy the non-hedged version when USD/CZK is low, and the hedged one when EUR/CZK is low? If the swings in currencies average out, why not do this for potential 'timing' I am thinking.

This won't still get rid of the risk of CZK appreciating when I retire, but will help me stay the course. CZK and EUR seem to have a higher correlation anyway. Sounds easier than managing multiple properties :)

sean.mcgrath
Posts: 462
Joined: Thu Dec 29, 2016 6:15 am
Location: US in NL

Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by sean.mcgrath » Sun Aug 02, 2020 4:15 pm

mrekvy491 wrote:
Sun Aug 02, 2020 3:46 pm
sean.mcgrath wrote:
Sun Aug 02, 2020 9:46 am
mrekvy491 wrote:
Sun Aug 02, 2020 9:34 am
sean.mcgrath wrote:
Sun Aug 02, 2020 9:26 am
What do you think your retirement currency will be? Likely in Europe, or South Korea?
Hopefully it will be CZK. Maybe there is a case for EUR, although part of me says that we could move somewhere else if CZK appreciates so much :happy
If it appreciates while you are still reasonably early accumulating, that is not a bad thing. It means your salary will let you buy more assets.

Property could make sense if you are the kind of person to manage it. I think EUR hedged equities are also an option, although I do not really understand / have not looked into them. You could also split US and non-US ETFs, and overweight non-US (although this is under-weighting a geography as well as a currency).
From what I read in this thread, I don't think I found a reason that I should not buy a EUR hedged fund. The hedged fund is synthetic but I read somewhere in this forum, that it is not as dangerous as one may think with new regulations in place. Will do more research but it could be worth a try if this is the case. Maybe I could have 20-30% of the EUR hedged version so the level of USD influence is more limited. I suppose I could also buy the non-hedged version when USD/CZK is low, and the hedged one when EUR/CZK is low? If the swings in currencies average out, why not do this for potential 'timing' I am thinking.

This won't still get rid of the risk of CZK appreciating when I retire, but will help me stay the course. CZK and EUR seem to have a higher correlation anyway. Sounds easier than managing multiple properties :)
I do think that the evening out is a very rough measure and can take decades, if ever. Definitely read the Wikipedia on PPP, and maybe look at the OECD data. I would personally take some action when it is more than 10 - 15% "off," but not try to seriously time it. When you get near retirement, you'll need to have another look. It could be that pensions, property minimize the exposure.

Topic Author
mrekvy491
Posts: 14
Joined: Wed Jul 29, 2020 10:43 am

Re: Need advice on currency hedging in Europe. Not in Eurozone.

Post by mrekvy491 » Sun Aug 02, 2020 4:26 pm

sean.mcgrath wrote:
Sun Aug 02, 2020 4:15 pm
mrekvy491 wrote:
Sun Aug 02, 2020 3:46 pm
sean.mcgrath wrote:
Sun Aug 02, 2020 9:46 am
mrekvy491 wrote:
Sun Aug 02, 2020 9:34 am
sean.mcgrath wrote:
Sun Aug 02, 2020 9:26 am
What do you think your retirement currency will be? Likely in Europe, or South Korea?
Hopefully it will be CZK. Maybe there is a case for EUR, although part of me says that we could move somewhere else if CZK appreciates so much :happy
If it appreciates while you are still reasonably early accumulating, that is not a bad thing. It means your salary will let you buy more assets.

Property could make sense if you are the kind of person to manage it. I think EUR hedged equities are also an option, although I do not really understand / have not looked into them. You could also split US and non-US ETFs, and overweight non-US (although this is under-weighting a geography as well as a currency).
From what I read in this thread, I don't think I found a reason that I should not buy a EUR hedged fund. The hedged fund is synthetic but I read somewhere in this forum, that it is not as dangerous as one may think with new regulations in place. Will do more research but it could be worth a try if this is the case. Maybe I could have 20-30% of the EUR hedged version so the level of USD influence is more limited. I suppose I could also buy the non-hedged version when USD/CZK is low, and the hedged one when EUR/CZK is low? If the swings in currencies average out, why not do this for potential 'timing' I am thinking.

This won't still get rid of the risk of CZK appreciating when I retire, but will help me stay the course. CZK and EUR seem to have a higher correlation anyway. Sounds easier than managing multiple properties :)
I do think that the evening out is a very rough measure and can take decades, if ever. Definitely read the Wikipedia on PPP, and maybe look at the OECD data. I would personally take some action when it is more than 10 - 15% "off," but not try to seriously time it. When you get near retirement, you'll need to have another look. It could be that pensions, property minimize the exposure.
Thanks for the suggestion. I will read more about PPP and see the lengths of swings.

I also was unsure about paying pension contributions in South Korea and Czech Republic at the same time, but now I think it could be a good thing.

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