I don’t know exactly, I would think only USD stocks are hedged?
To your second questions, I think he refers to the average 0.3% TER hedging adds.
Here is the same content from the chapter about hedging on his blog (in German though):
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Well hedging certainly does cost something, it can influence the return, but still a cost, like an insurance premium. The article doesn’t once mention bonds?
According to the ZKB article: “The appreciation of the franc against the USD has been at an average of 1.5% per year for almost 50 years. Hedging the USD cost an average of 2.7% per year during this period – in line with the average interest rate difference between the USD and CHF. The continuous appreciation of the CHF was therefore not sufficient to compensate for the costs of currency hedging. On balance, there is a loss-making transaction of 1.2% per year on average (=1.5% appreciation minus 2.7% costs of currency hedging), which accumulates into significant losses over time.”
Conclusion: “If the interest rate difference is higher than the expected currency appreciation, it is not worthwhile to hedge the currency due to excessive costs. As we have determined in our analysis, currency hedging is not worthwhile if the interest rate differences are greater than two or even three percent. In the event of interest rate differences between 1 and 2 percent, the result is neutral”
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Okay, thanks!
Just to add on your points:
a smoothed out curve might make someone sleep at night and not quit their investing plan, this is more on the behavioural side but it could play some role.
Yes, but as @oslasho points out, including more data in the time window makes the return bigger. Could be interesting to see the same column with “20 years” instead of “10 years”
@ternes11, the ‘cost’ of hedging (for some countries other than Switzerland it’s a ‘positive cost’), tends to bring the interest rate of the country you’re investing into (bonds), close to the domestic (bonds) interest rate, there’s nothing around that:
(bonus: and according to real interest parity, all “domestic” interest rates are equal after taking into account domestic inflation… there is no arbitrage opportunity in the long term!).
Your argument is (?), if I don’t hedge, I won’t have this cost, so my interest will be the one of the foreign country.
But this is wrong, because if you don’t hedge, you’re taking up a different risk (currency risk instead of hedging risk). And the same paper mentions that
investors might expect a similar result when remaining unhedged over the long run, with currency returns producing a similar adjustment for underlying fundamental differences across markets
Here is the source btw.
Onto the ZKB article I believe that their reasonings make sense for short periods of time. Say you have a bond, and you want to use that bond in e.g. 2 years to buy a house. In that case, I believe it is beneficial to do the kind of reasoning that ZKB is doing (hedge if the interest rate differential is…), so that you don’t lose money in the short term, which is the horizon that interests you.
For stocks, refer to my original post.
PS: can you please point to where the topic has already been discussed?
I did a search before posting (probably not thorough enough) and I couldn’t find anything.
This thread is about hedging foreign equity, not bonds? The article also only covers hedging in the equity context?
Why on earth would I do that? (With perfect markets ok, but that would assume no taxes, no illiquidity, no transaction costs etc.) Keep it simple and just have (or convert) your bond in the currency you want to use…
I think hedging currency makes sense in the short-term if you happen to know that a currency is depreciating above average, which of course no-one knows, which is why for (private) investors it makes no sense IMO.
Oh, I just remember having seen before hedging discussed on this forum (and me chiming in a more opinionated way than really necessary … 
).
If you just search for ‘hedging’ you’ll come across a couple of threads, but I can’t really point you to the canonical thread for the topic.
Hedging long term equity portfolio for currency risk is mostly meaningful with respect to peace of mind but not with respect to actual returns. Because if you expect higher returns then there is no research to back this up.
I see it like following
- hedging is a cost , so it should impact returns.
- in Swiss investor case, the idea of hedging always comes with assumption that CHF will appreciate against the world. What if it doesn’t happen?
- I would be surprised if expected appreciation of currency is not already somewhere in cost of hedging . It cannot be the case that one can expect to always benefit from hedging
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Looks like we need to getvthis conversation back to the basics aka Data. Hedging Shares is a very important tool to protect against Governments‘ Financial Repression.
In theory, Hedged and Non-Hedged Shares have the same return. This however only applies if the central banks allows the interest rates flow to their equilibrium. Once that is given, FX losses equate to the Delta of interest rates and there is no point to hedge shares.
If this is not given however, you shall hedge the shares into a currency without financial repression. What does this mean in practical terms?
- EUR and JPY Yen domiciled shares shall be hedged (whether against USD or CHF dosnt make a big difference
- EUR or JPY domiciled Investors shall still hedge a decent part of their shares against a non repressed currency (e.g. USD or CHF)
Data that underpins this:
- Financial Repression by EZB: https://www.msci.com/documents/10199/0dd2dc8e-68fa-451c-8541-7b600b11e5e4
- Financial Repression by BoJ: https://www.msci.com/documents/10199/80ee05e1-1732-4d91-8393-6697063c697f
- NO financial repression by FED: https://www.msci.com/documents/10199/5e1a3133-0c18-45d7-8804-57d0c2079525
Make it make sense. You hold internationally diversified stock, most of it with equally diversified international economic activity. You want to speculate on FX, go buy futures. You can even lever them as high as it lets you sleep soundly (or even more if you enjoy that, up to a maximum of the broker margin calling and liquidating you).
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Since VT (or VWRL) is highly promoted here on this forum. What does this mean for investors who invest in these funds? These funds include multiple underlying currencies but if one were to hedge some of them, then it would become quite complicated excercise.
I find it a bit difficult to accept that one would like to get diversification from international equities (because it is not so easy to guess which markets might perform) but at the same time somehow is pretty sure to be able to guess which way the currency pair might move.
For me it is simply not possible. And to be honest, few years back, JPY was safe haven currency too.
Maybe what I posted over in the 2024 outlook thread is better suited here, because when we’re already in the business of splitting the world into multiple region ETFs, it becomes trivial to currency-hedge specific markets.
To recap: currency hedging is universally seen as not worth it for long term stock investements. But I’ve found two articles for the Swiss investor that are not completely opposed to it:
Improve your long-term returns with currency hedging – True Wealth
TLDR: hedging reduces volatility so it’s good for risk-averse investors. Also because the loser loses less than the winner when hedging (?), it makes sense to hedge 50% of the portfolio
End of zero interest rates: Check hedging foreign currency investments now! – ZKB
TLDR: hedging makes sense when interest rate difference is lower than 1%, so fully hedge investments in EUR and JPY.
The second article makes more sense to me, so basically one would put together a world portfolio with EMU hedged to EUR and Japan hedged to JPY, and then add the other regions without hedging?
I want to hit my face against a wall every time CEOs (!) of Investment companies say things like:
- “your portfolio should be invested into different economic regions”
- “a global portfolio is […] exposed to fx risk”
- “this dilema is especially relevant for Swiss investors because the local stock market is concentrated in pharma and banking” (so foreign stocks need to be bought)
- “CHF is seen as safe harbor and rises in crisis, this increases volatility of foreign stocks”
- “the exchange rate risk from holding companies in foreign currencies can be secured with fx hedging”
So local multis like Nestle or Roche have no fx risk, because they are bought an sold in CHF. How convenient … how wrong.
But there are too many professionals that never questioned what someone else told them and continue to spread wrong information.
This volatility has nothing to do with the assets in your portfolio and everything to do with the CHF (or rather your consumption in CHF). It might look similar but it is not the same, and certainly has nothing to do with the denomination of your assets.
That can be true if you, as he recommends, hold a position less than 100%. If the long term expected return of two assets is 0%, but there is uncorrelated volatility, rebalancing actually gives you a positive expected return.
Two other nice facts are:
- This can result in a positive expected return, even if both assets on their own have a negative expected return.
- A position bigger than 100% on the other hand loses return from rebalancing (against the short position). This is also called volatility decay in leveraged ETF.
Link doesn’t work. Must be this one:
Their quantitative research shows that interest rate parity did not hold for the given period for large and small interest rate differences for CHF pairs:
I do have my doubts though. I see no explanation on why this should be so and continue to be so into the future.
If it were true, that would still not tell us anything about hedging of stocks. It only tells us that going long-short on currency pairs has an expected return different from 0. You should buy or sell contracts depending on the interest rate difference. I also don’t know if the risk adjusted return is on the efficient frontier, or if it pairs well with a given portfolio (e.g., 100% stocks).
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Thank you for posting your thoughts. I’ve fixed the link.
When comparing the same index/fund with and without hedging, the differences are usually there but not huge, and the two variants regularly trade places on what’s performing better. For Japan however, the difference is staggering: the CHF-hedged MSCI Japan gained 82% in the last 4 years, while the unhedged MSCI Japan in CHF gained just 24%.
Well, isn’t it the famous yen carry trade?
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Do you mean the crash last month? Even excluding that, the difference is about the same.
I think hedged vs unhedged is very complicated problem. You would find evidence for either case.
My conclusion is that whatever the investor decide (hedged or unhedged), they need to stick to it for very long term
And then expected return hopefully would be same minus costs (hedging costs , TER) . But there is no conclusive evidence
JPY lost significantly its value over the last few years against all major currencies. So hedged version would have performed better
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No he means the trade itself.
Meaning going short JPY and going long another strong currency. Normally you‘d do this with high interest currencies. It just happens that the CHF is strong and appreciates rather than paying interest.
And you are effectively doing that trade when currency hedging your Japan exposure.
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No, I don’t mean the crash last month, but a steady depreciation of JPY vs. CHF last what, 10 years?
The problem with hedged equity that I see is that there is an equity investment overlayed with FX options. While I may believe that hedged equity can have a lower volatility than the unhedged one, I don’t believe that you can have higher long-term returns with hedging. Hedging is an insurance. You don’t earn with insurance, you pay for it.
By themselves, short term FX fluctuations vs. the expected long-term trend can go in either direction. Most probably this time it was pure luck that JPY systematically depreciated against CHF more than it was expected. I don’t see a point in making any kind of theory out of this.
I would be glad to be corrected, as always, but until I am convinced in something, I am happy to use the efficient market razor and stick with what is known to work.
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