International International Shares - Hedged vs Unhedged?

@dunno it would great if you can share your views on this also. Your knowledge, analytical skill and abiliity to think clearly is way superior to mine. I have to admit with all the investing decisions I’ve been faced with I find the hedged vs unhedged issue a more difficult one. I’m a bugger for getting buried in detail to the point where at times I can’t see the forest for the trees. There are just so many variables with the hedging decision including a strategy that one’s partner agrees with.

I think what I might do is create a few posts on this so some of the issues can be discussed separately to avoid a muddled mess from me trying to cover all these at once. I’ve also copied snippets I’ve found including those from younger less experienced investors who I thought had interesting insight into this. There are some holes in their conclusions but it gets one thinking.

But if it’s not of interest I’ll provide our decision up front now which is to remain unhedged in the medium to longer term but being prepared to revisit the issues annually with my wife based on our view of Australia in general. The main reason being is that hedging is an overall portfolio decision rather than equity specific. And given that our overall portfolio global exposure target is a maximum of 30% and our reasonable level of wealth the argument in support for hedging appears to be negligible even though we’re in the peak SOR zone

But saying that I’ve got this annoying feeling that something is still not satisfactory to my over active mind.

There’s so many aspects relating to currency issues but not many seem to be interested in them. SOR is a very important issue so I suppose most accumulators aren’t Interested in it and surprisingly even retirees / near retirees often tend to disregard it. Anyhow I’ll keep posting snippets to see if it anyone is interested in it.

 

Ok for the first snipet posted on another site:

As stated earlier I’m not suggesting I agree fully with these comments but I would like others to offer their views on each one as I present them.

International exposure I think is important for shallow and deep risk with younger retirees potentially exposed to both. Trying the balance both might be a challenge for some given their circumstances.

Also the aim is still to keep the approach simple which surprisingly even Hamish Douglas does in regard to his personal hedging strategy.

 

I’m certainly interested in the topic I’ll be following your posts. I am prepared to change my mind if evidence arises or circumstances change. Like you I’m not certain enough to close this aspect off as finalised for ever and a day.

My view is still unhedged for long term equity. But in saying that I’m not far off switching accumulation from VGS to VGAD. It’s a looong term valuation judgement thing. The exception to the rule if you like. No fixed allocation to hedged vs non-hedged, no rebalancing and certainly no selling unhedged to buy hedged on a currency view but am prepared to take valuation into the judgement at time of purchases. My geographic and value factor tilts don't have hedged options available - That's O.K I I don't think I would use them if they did. But for 3 basis points when the TWI is low enough the hedged version of VGS has merit if you think there is a probability of the dollar being stronger during some part of the de-accumulation phase. As I hold international exposure in a SMSF there will be a mandatory de-accumulation phase. A mixture of hedged and unhedged parcels could offer flexibility as I transfer and reset things into personal holdings. Holding in the SMSF also helps minimise the tax consequences of lumpy hedge income.

Thats where I am at the moment - looking forward to any snippets you dig up.

 

I would say “it depends”;
- what currency you ultimately want to hold / spend later - first and foremost - and,
- and where you think the currency is going to go.

At the height of the mining boom when the Aussie$ was over $1USD - and I felt the only way was down - I was investing in unhedged USD & getting an extra kick as the Aussie went down.

(An extra bonus was I was working overseas and could elect to take my expatriate salary in USD which was fixed once per annum at an internal company exchange rate ... which on the way down was always lagging behind the market forex rate ... equated to an extra 5-10% per month in salary as I just converted all my monthly surplus to Aussie$).

My view on the Aussie$ for the short / medium term is down vs USD ... but not as spectacularly is it dropped from $1.10 to 80c.

 

This comes back to Hamish D’s points. Ok there’s the mantra of pick either hedged, unhedged or set combination then stick with it. But say the Aussie dollar against the TWI gets outside the average range of say for example 65 - 85 cents does one just blindly keep sticking with unhedged or hedged? It just seems illogical to me (assuming a deep risk event hasn’t risen in Australia) that when when it gets below say 65 - 68 cents one would just keep blindly adding to VGS when for an extra 3 bps VGAD is available?

Of course I expect the criticism of my comments being that it reeks of market timing etc. But currency is not like the stock market in that it can generally go up and compound forever. So I feel it’s possible based on the data to set some “reasonableness” bounds just like H Douglas highlighted in his interview. And it’s not even so much that I’m trying to predict the future direction of currency, it’s simply what is at the time of new cash for accumulation or drawing cash in decumulation. Importantly by holding both hedged / unhedged it offers a choice that makes sense given the circumstances.

@dunno like you I’m not one for selling say VGS or VGAD for gains or rebalancing etc. Simply in accumulation new cash goes to hedged vs unhedged based on simple reasonableness rules. In deaccumulation forced upon us in Super one has the choice to realise what makes sense at the time given where the Aussie dollar is at. Super pension withdrawal may be used for retirement spending or more likely reinvested outside the Super environment.

Importantly as you mentioned given the nature of hedging the hedged product is best housed in the lowest taxed structure available to the investor.

So far it seems we are generally on the same page.

 

Next thought bubble, to be challenged please if others feel it’s incorrect.

It’s often mentioned that given our concentrated share market it’s worthwhile investing in small caps for greater diversification. Some investors use this as an excuse to avoid no / less global exposure. But the reality is if banks / property / miners go to **** the economy / market in general takes a hit. How valuable will the ASX small caps really be as a diversifier in such a risk scenario?

Enter hedged global equities (perhaps lower risk large cap developed). Huge diversification compared to holding ASX small caps but in our local currency. Wonderful diversifier against local ASX sector concentration. In the case of VGAD it’s also likely to be much lower fee compared to a decent ASX small cap Mgr.

But there’s the trade offs. Tax issues relating to hedging if in a higher tax environment. No where near the protection as unhedged against major home country risk but then ASX small caps wouldn’t do that anyway.

 

It doesn’t reek of market timing.

It smells like having a view and backing it with an investment decision.

Forex, property markets, regulatory environment, tax regime, etc ... we all should have a view rather than just be passengers.

We may be right or wrong, but at least we took an informed decision.

 

I suppose nowadays I’m sort of in the middle. My investing approach is relatively passive but as a retiree preserving our wealth is just as important as growing it especially being in peak SOR zone. Risk management has moved more to the forefront. Balancing this at times can be a challenge. In particular I’m a great believer in equities so managing risk simply by adding an ever increasing amount of fixed interest is not the path I want to take. So it means thinking more carefully about managing equity risk.

 

I get it.

I’m not retirement age or by means yet. Redundant & a good 22 year service based package.

Suddenly without a time-for-money income, investing objectives change. Suddenly capital preservation leaps up the priority ladder.

So. Where do I sit?
- Property portfolio for looong (Syd & NSW) term capital growth.
- Liquid funds into LICs for regular & hopefully growing income.
- and a few direct stocks - esp banks which I felt were oversold on RC fears. Kind of feels nice NAB pay me a 11-12% dividend while I pay then 4-4.5% interest.

 

Speaking of risks such as regulatory / tax although I’ve been a great fan of LICs for over three decades I’ve been progressively increasing our exposure to VAS. It’s not so much if one is better than the other performance wise but diversifying between company vs Trust structure.

I do feel that it’s only a matter of time before franking credit refunds go which could potentially hurt LIC more so than ETFs being Trusts. Further LICs feature more heavily in personal names where franking credits can be better utilised rather than in the SMSF. The SMSF holds most of our cash / term deposits, all international equities and ASX weighted more to trust structure being an ETF (VAS).

 

Interesting interview in general but a short discussion around the 18 min mark is relevant to this thread:

 

Seems we are.

Unnud and Gordon gnieerga....... Its all back to front who's going to keep us honest?

 

I note Vimal Gor makes mention of the underlying positive trend in the AUD.



AUD/USD since Aussie floated.
Trend line is in dotted Blue, Average is in Red.

Is 35 years of free floating currency long enought to base hedging decisions on price relative to trend? or do you adopt the long term wash arguement and base decisions on the long term average exchange rate???

 

He he, yes.

Wanted to thank you for your earlier post. Helped clear my thinking after getting buried in a couple of weeks of reading / research.

I could post further stuff but really I think Hamish Douglas nailed it with his common sense simple view. Nothing really new I suppose but just needed reminding of it as once one gets deep into researching it’s easy to get lost in stuff like ideal split, rebalancing, dynamic hedging etc etc. The niggling feeling in the back of my mind was simply that I would not feel comfortable sticking with 100% unhedged when based on common sense reasoning hedged global would make much more sense when adding new cash at a given time.

So like you @dunno I’m still a believer in unhedged for the long term but willing to add hedged global if it makes sense valuation wise. As for rule / guideline very simple also. Always unhedged unless Aussie dollar falls below the 65 - 70 cent range then hedged. Over time there may need to be some adjustment based on the data / Aussie outlook. But simplicity being the goal

Of course like you suggested and what interested me in hedged global also is given the eventual forced withdrawal of SMSF pension having the option to realise either hedged or unhedged depending on the currency at the time is very atttactive. Then again if you don’t need the Super pension to meet lifestyle expenses you can just sell tax free in SMSF then repurchase outside Super.

All the above fits in nicely with SOR risk and withdrawal strategy in retirement.

Other simple rules of thumb include: unhedged for EM - appreciating currency, potentially higher interest rate, difficult and costly to implement; and unhedged preferred for global small caps given the volatility. So really given cost and most effectiveness hedging best used with Global developed large / mid cap with VGAD being a perfect fit.

Next topic for a later post worthy of discussion is global property / infrastructure. Generally I would have thought hedged would be preferred given the high income distributions but I’ve seen others suggest it depend?

 

Yep that’s another reason why I posted it, thought Gor’s long term view on Australia was very interesting. But we can only make our decisions on what we have. Either way over time hopefully one would end up with a mix of hedged / unhedged in the portfolio.

Unhedged for me is still mostly an insurance policy against major home country risk rather than performance. Like all insurance we hope it isn’t needed but it takes priority over hedged global in that respect. But having some hedged global when opportunity presents itself seems like a worthwhile idea for reasons we’ve just discussed.

Of particular interest was Gor’s comment of “65c is an idea”. Of note is that same figure is mentioned by Hamish Douglas. Both these guys I have great admiration for even though I’m a believer in passive investing. Make of it what you will I suppose but there’s a message in that which I’m prepared to take onboard.

 

Hey @Nodrog

I’ll comment her rather than derail the Franking thread.

A lot of our stupidness as a country is already priced in. I’m sure you have noticed that there has been a huge technology bull raging for a while now which Australia in a AUD$ has basically completely missed. Sonner or later there will be another mining up cycle come along to bail us out. That’s the sort of big picture that drives my currency expectations and a simple valuation metric seems to fit the bill better than trying to time the cycle itself. I have decades for it to pan out.

Sadly, to me the Australian economy seems like a metaphorical brother in law who works in the Mines. When he’s got a job, he’ll be around with all his new play toys showing you how rich he is. Two years later he’ll be living in your basement with no job, no money, and no new skills to get a different job – but sooner or latter the mining will come back and he’ll be off again, at least until Christmas when he’ll be back to show you all the latest toys and the cycle rolls…….. Despondency that another mining job will ever come along will play out like late 90’s on the currency.


If we didn’t **** the last mining boom up against the wall, how come we didn’t make a dent in our Net Foreign Liabilities.


As a country we remain susceptible to tightening global credit. When things get tight, our
currency, monetary and fiscal policy will have to sing to the tune of global capital flows (and it will). These sorts of situations will playout relatively quickly and dramatically like 2008 did on the currency.

Well, above is my simpleton view.​

 

At 59 and wife 55 we’ll also likely experience a few more mining booms in our lifetime. We unfortunately have no control over the Gov’t pis*ing money up against the wall so it’s up to each investor to try to compensate somewhat with their own financial management.

This is why I’m now feeling more comfortable with being prepared to have a mix of hedged / unhedged global equities. Improved risk management and greater opportunity for accumulation / decumulation.

Oh how I’d love the see the Aussie dollar above parity again whilst the US has another lost decade. Reversion to the mean perhaps in the medium term? I’ll be a lot greedier next time round.

This chart (Aussie / US) certainly highlights what a painful ride it could be for a retiree with higher global equity exposure drawing on their capital who bet it all on the wrong side of the currency. Of course when and over what time period the asset was purchased is important but it does make me think that a mix of hedged / unhedged might have made the ride less painful?

 

A snippet I collected from an Aussie at Boglehead forum (edited) that might be helpful to those new to currency issues and trying to formulate their own view:

 

Winners and losers in sharemarkets, 2017/18 - Cuffelinks

 

Just saw this, quite an interesting article from StockSpot on:

What are the best Global Share ETFs?

What are the best Global share ETFs?