How do you hedge your currency risk?


#1

Hi guys,

I’m thinking about setting up the simple 3 ETF portfolio as suggested on the Blog but I have a question regarding “Vanguard Total World Stock ETF”

As it’s USD denominated, do you hedge your currency risk somehow?

With strong CHF and Mr. T ruling the US, I’m kind of reluctant about investing in USD. I would go for a currency swap but that means knowing the investment term beforehand.

Do you hedge with interest rate swaps? I’m curious to hear your coments about investing in USD from CH.

Cheers!


#2

Hey @citricut,

@ hedging: the long term passive investor typically does not bother for hedging, as hedging only gives a very short term protection <<1year, unless he does it himself. then he is effectively market timing.

proper diversification among currencies is the only real response i can think of. also consider that this fund probably has some 50% US-denominated assets, the rest may be something else (i.e. EUR). Regardless of the whole ETF being in USD, their numerical value in USD would rise according to the devaluation of the Dollar. Therefore only that fraction of the ETF is exposed to USD current risk that is actually USD-based.

I can forward you to my own and other’s portfolios. In my case, even though 80% are traded in USD, only 30% of the underlying assets are US-based. I will add some EUR-exposure once the absolute value of my portfolio increases a bit :smiley:


#3

Thanks a lot @nugget

I hadn’t thought of how the appreciation of other currencies’s assets would increase the USD value of the fund.

I like your asset allocation, I definitely want to put some CHF in emerging markets.
Will post my portfolio proposal when I finish the full picture of my equity. March is a complicated month as I simultaneously get paid the bonus, buy new staff shares and get paid dividend on previous ones. Plus I have to pay the last big credit card bill outstanding after moving home and buying new furniture, a experience I hope I don’t repeat in many years!

Cheers


#4

Could somebody please explain how to unterstand this currency risk for beginners like myself? From what I read so far I see that for stock ETFs it doesn’t matter if you have them in a different currency because companies deal with different currencies themselves, right? But it seems to be not the case for bond ETFs, which you need to have in your own currency. Why is it so with bonds?


#5

so in first approximation currency risk means that if you ownn assets denominated in other than your native currency, they might lose value relative to native currency. They might also gain.

that means, if I have all my ETFs in the US, and the USD falls 30% vs. the swiss franc, so does my portfolio.

now on a closer look you will find that the currency risk is not based on what currency this asset is listed, but how it’s underlyings are denominated. If f you have an ETF “A” of companies domiciled in US and all these companies do their business only within US, then this ETF is subject to the full currency risk USD-CHF.

But if you have another ETHF “B” domiciled in US and denominated in USD, with only russian companies that do their business in Russia, then you actual currency risk is that of CHF-RUB, and, but no risk about USD.

now the reality is that all the big US companies have a large fraction of their earnings all over the world in almost any currency, so an SP500 ETF is actually quite diversified in terms of curency risk


#6

I don’t really get the point of this argument. As I understand it, the gains from stocks come from two sources: dividends and stock price.

The dividends reflect the company’s earnings, so notwithstanding in which currency the company earns, the more they earn, the better. So in my understanding it doesn’t matter how and where they earn the money, they will be still paying the dividends in one chose currency. If they earn mostly, say in AUD, then what I receive in dividends is already including the possible unfavourable AUD-USD-CHF exchange rate.

But why would the price of the stock in any way depend on the exchange rate? The price is just an estimation of what the company is going to be worth in the future. And the growing price is the main driver of return from stocks, right?

What about bonds and currencies? Why does it make sense to buy Swiss bonds with zero return in comparison to US with small returns?


#7

Currently it does not make sense whatsoever to own swiss bonds with negative interest rates.
As regard to US bonds, it depends of who the issuer of the bond is, but :

  • Treasury bills return a very low yield (the current 10 years “risk-free” rate is 2.87% (see here)
  • Risky or very risky companies bonds are not yielding much more : for instance the latest bonds from Tesla have a yield to maturity of 6%. That is quite a big risk for not much returns.

So to sum up, the current gains from US bonds are quite small compared to the fluctuations of foreign exchange rates. For instance, between last november and february, USD/CHF went from 1 to 0.92 (that would have been an unrealized loss of -8%).

So my take is that when dealing with bonds, you want them in your local currency if the rates make sense, which is not currently the case in CH.

As for stocks, the more correct (but highly impractical) way to evaluate the value of a stock is the method of John Burr-Willians which states that the value of a company for an investor is the present value of all future cash-flows. (It is very impractical because forecast of future cash-flows are very hard to make, and the discount rate used matter a lot; it is a little bit like the Hubble telescope : change your parameters from 1mm, and you end up studying a totally different galaxy).

So in theory, if the earnings (and thus cash-flows) from a company are earned all over the world, they should not be too dependant on the quoting currency. It the latter loses value, the earnings increase and vice versa.

(However, I would be curious to see what is really the part of the earnings of the S&P 500 earned in America vs what has been earned in the rest of the world. )


#8

It’s gonna cost you, this insurance ain’t free. You’re going to be paying both USD interest and negative CHF interest, about 2-3% p.a. at the moment

Exactly. For example, if CHF drops, all other things equal, Nestle’s profits (expressed in CHF) and shares are going to skyrocket - they’re making most of the money abroad, so same amount of abroad earnings are going to buy them more CHF to pay you your dividend and what not. And vice versa. it’s largely a USD company that just happens to be hq’d in CH with shares correspondingly traded in CHF

Says who?? If you’re going to hedge the currency to CHF at the moment it’s only going to destroy the little bit of interest there is to have there

It does not


Non-Relevance of ETF Quotation Currency
#9

Hedging the currency risk is plain stupid because on the long run it costs more than what it brings.
If you do not like negative interest from safe swiss bonds you have the chance to be a small investor and you can use a bank account with no negative returns as long as you do not exceed a high six digit number. If you stay within 5 digit number your money is even guaranteed by the swiss government.
With 2.7% return even US bonds are unattractive. You will be taxed on the 2.7% income but the USD will probably continue to loose value respective to CHF.


#10

I am not so sure. If you think the stock market and non-CHF currencies are about to crash and you have a large amount of CHF you don’t want to keep in cash for some reason (more than what esisuisse insures maybe?), having a predictable -0.7% rate is better than the -XX% you might expect for stocks or -X% for bonds in other currencies. It would be an unusual situation but not impossible.


#11

as long as you have <100k per account, cash is 0.0%, up to about 0.5% in the right places, risk free.


#12

That’s a very good question.

If you are a local American company, you purchase and sell your goods and services locally in USD, then you won’t be so much affected by the exchange rate of the USD to other currencies. Of course, you could be affected indirectly: if USD gets stronger, it is a good chance for importers to sell at cheaper prices, competing against you.

However, if a large part of your business is about exporting goods to Europe, then your prices are fixed in EUR and you can’t change them so easily. That’s why you hear about weakening the dollar to stimulate US exports. They print new USDs, which means “free money”, the dollar gets weaker, which makes US exported goods cheaper, and imported goods more expensive.

An interesting thing to see is that VUSA (top 500 American companies) has the lowest volatility when denominated in USD, VEUR in EUR and SPI in CHF.


#13

I was to create a new topic, but I saw this one, so joining this thread.

I come across with this recent Vanguard paper: https://personal.vanguard.com/pdf/ISGPCH.pdf , so thinking loudly:

  1. I am not sure I understand that sometimes it is argued the fixed income should be (mostly) from domestic bonds (I guess to eliminate currency fluctuations). Why should it be any different than diversifying the equities ? Why should one have a huge home bias for bonds ?

  2. Figure 1 in the paper shows 3y trailing returns of stocks are affected by currency fluctuations, but 10y returns are not. So I take this as if there is a possibility you sell your foreign currency positions in short/mid-term, then hedging may make sense.

  3. Figure 3 and the corresponding section in the paper says if you have unhedged fixed income positions, their volatility is largely (⅔ of it) caused by currency fluctuations (which is strange since main point of fixed income is to have low volatility), so they recommend hedging the foreign currency part of fixed income. This is also what I do at the moment, I keep the bond ETFs hedged to CHF as much as possible.

  4. Figure 4 and the corresponding section in the paper says the volatility of unhedged foreign stocks are affected by currency fluctuations to a small extent, and this effect can be either positive or negative.

  5. From a portfolio point of view, it is said in the paper that a conservative allocation (more bonds) may hedge the equity portion as well, but an aggresive portfolio (more stocks) can keep foreign currencies as it is and only hedge if short-term fluctuation matters (as in point (1) above).

  6. One point that is extremely different between US and CH investors is the market size if you do not have a home-bias, so even if keeping the bonds hedged to local currency, for a US investor it means 50% of stocks are in USD, whereas for a CH investor only 3% is in CHF. So maybe it may make sense to hedge also a portion of stocks to CHF, as far as I understand from the paper, and sounds reasonable to me as well.


#14

well then check that you’re not actually losing money as after you paid ~ 3% for hedging there ain’t gonna be much interest left


#15

I guess/expect it should be correct. Does it make sense or do you think it is strategically unnecessary or tactically at the current interest rates ?


#16

I think it’s too expensive, plus I don’t care that much about swiss frank, not gonna retire here.

Also if return after hedging is negative it doesn’t matter what I or anyone thinks, its just dumb not to park money e.g. on 0% interest savings account instead


#17

Where are you gonna build your cave, hedgehog? :smiley:


#18

I’m a global person, don’t want to be tied to a particular country. I’ll move wherever my interests take me, if I’d still want to work in my field probably US, otherwise some sunny country like Malta or Thailand


#19

Nice. So you plan in $?


#20

Hey, are you reading my mind or what? That’s what i’d like to do as well! :slight_smile: Preferably by keeping my Swiss domicile.