International International Shares - Hedged vs Unhedged?

Great discussion all around guys as always. I saw the same post on the Bogleheads forums a couple of days myself and it has also gotten me thinking about this topic.

Am I crazy for thinking though, that if one already has a majority of their holdings in Aus equities they won’t really need to hedge? But if you were to tilt towards a more international focused portfolio or go full international then you would have to ask how much of your portfolio are you comfortable exposing to currency risk and from there you can decide what % of your portfolio is hedged or not.

I have been going 50/50 Aus/Intl (unhedged) as this has been easier to manage (I just alternate my purchases) and fits with the general wisdom of going 50/50 with regards to currency (for least regret, not necessarily the most optimal). If I were to push my Intl allocation higher however I would probably start purchasing VGAD instead to maintain that 50/50 currency exposure.

Vanguard’s diversified funds only introduced currency hedging when they reduced their Aus allocation, which was to diversify away from the ASX without introducing additional currency risk. I think VDHG at the moment has about 60% exposure to the AUD.

 

Many variables.

How far are you away from retirement? If a long way from retirement, more exposed to deep risk and given currency is a wash over the longer term then perhaps unhedged is preferred.

In calculating the amount of allocation to local currency all investments need to be included such as cash, bonds, investment property etc.

As a retiree without employment income I want a lot more of our assets in local currency. I choose to have a strong home country bias through owning ASX and cash / term deposits rather than hedged international. Being older I’m comfortable with that. Deep vs shallow risk reasoning in part.

Even though I often harp on about the importance of protecting against Home country risk I think some get too paranoid with it especially given Australia’s circumstance.

I still favour unhedged global exposure but the earlier discussion was in relation to “valuation”. When the Aussie dollar is well below it’s normal range and in the absence of any deep risk event then valuation wise it could make sense to havour “hedged” global assets.

 

Another interesting discussion could be had about real assets such as Global listed property / infrastructure. If one chooses to treat these as separate asset classes (through overweighting) then being hedged might be more suitable. That is given a significant part of their return is from income distributions hedging would ensure the income is not overwhelmed by currency volatility.

But it depends on why one is including these assets in the portfolio such as growth / correlation vs income etc. As I said earlier this is another topic I’d look forward to others offering their views.

Any thoughts from the gallery?

 

Ok continuing on from my previous post here’s an extract from an article on hedged vs unhedged listed property:

I know this Is of minimal interest to many here but any thoughts?

 

Still talking to myself.

@The Falcon (you invest in IFRA), @dunno are you familiar with the following.

HEDGING - TOFA ELECTION by MGR to SMOOTH DISTRIBUTIONS.

I’ve never really looked into TOFA to date. But to investors in HEDGED Global assets wanting smoother distributions it’s very important. One of my dislikes of many Hedged products including Vanguard’s funds is missed and / erratic income distributions. But those Mgrs who elect to use TOFA can significantly improve on this.

Here’s an extract from VanEck relating to their IFRA ETF:

Do you like your income smooth or crunchy?

Thoughts?

 

So if during the accumulation phase and the Aussie dollar were to tank to let’s say $0.50 then I imagine in that instance if one was buying International equities it may be “better value” to purchase the hedged version, am I understanding this correctly?

 

Yes, assuming no extraordinary circumstances invalidates it.

 

I don't lust after income smoothness. so whether a fund implements TOFA or not doesn't worry me. If I had a personal choice - save the admin expense, I'm O.K with lumpy. Other may want smooth, to them it may be important.

 

Grrrr, no one will “sensibly” discuss my posts here:

 

At last, extended dummy spit cut short thanks to @dunno, he who likes it irregular and lumpy.

Great point, especially the admin cost. Each time I’ve looked at so called lower correlated risk asset classes such as Global listed property and Infrastructure (only overweighting in reality) the FEE in part is just too high to warrant further interest.

If one is content with market weight of these asset classes (sectors) then the fee for VGS / VGAD is only 0.18% / 0.21% but for IFRA (hedged Global Infrastructure) it’s 0.53% and for DJRE (unhedged Global Property) it’s 0.50%!

And if volatility is of little concern, say for example the natural yield of the portfolio is more than required for retirement expenses, then it’s doesn’t appear to justify the cost.

Where’s @The Falcon, I’m sure he’ll have some excellent counter-points?

 

Hamish Douglass and Andrew Clifford tackle your questions

 

This article may be of interest:

Understanding how currencies affect international ETFs

Understanding how currencies affect international ETFs

 

Hey @dunno, has your view on hedging changed since our discussion on this?

It seems that it’s getting closer to if not already time to consider hedged international? I’ve been distracted with other things recently so haven’t been following much of what’s going on in the markets.

As discussed previously the “currency is a wash over the long term” is well and good but retirees time frames are generally different to that of younger accumulators.

And then there’s the argument that even if hedging removes much of the benefit of country risk protection it does provide much greater diversity in one’s portfolio from a stock specific and sector view. Eg we often hear of the benefit of investing outside the ASX Top 20 / 50 to reduce concentration risk when it fact investing in hedged International removes much of the currency risk but provides dramatically greater protection against concentration risk.

As you mentioned the valuation opportunity is a biggie. Given that currency can go in a given direction for long periods of time as a retiree it would make me uncomfortable blindly buying VGS when the AUD is getting into relatively lower territory. Although not interested so much in the timing aspect If global markets correct our dollar will likely go down with it. In such circumstances having the option to invest in hedged VGAD would likely make more sense than unhedged VGS especially for some retirees who can’t necessarily sit back and relax thinking to themselves “she’ll be right mate, it’s all a wash in the long term”!

This is purely aimed at our SMSF for reasons discussed earlier. And like you mentioned above these are for eventual SMSF de-accumulation (not selling etc to move from unhedged -> hedged -> unhedged ...).

 

Allocation to underlying Vanguard funds VDHG As at date 30 Apr 2019
Vanguard Australian Shares Index Fund (Wholesale) 35.8%
Vanguard International Shares Index Fund (Wholesale) 26.8%
Vanguard International Shares Index Fund (Hedged) - AUD Class (Wholesale) 15.9%
Vanguard Global Aggregate Bond Index Fund (Hedged) 7.0%
Vanguard International Small Companies Index Fund (Wholesale) 6.6%
Vanguard Emerging Markets Shares Index Fund (Wholesale) 4.9%
Vanguard Australian Fixed Interest Index Fund (Wholesale) 3.0%

Hedge for the short-term, unhedged for the long term as it will balance itself out.

 

You could use a formula like this to determine hedged (VGAD) allocation (1.4-AUD/USD)^5 [Assumes range from 0.4 to 1.4].

Definitely not advice.

 

Perhaps.

But I’m thinking along the lines of @dunno in that buying hedged vs unhedged is simply due to valuation opportunity. Although in my case as a retiree there’s a risk management aspect in the medium term.

That said, I’m also very cognisant of the importance of protection against “country risk” that “unhedged” global equities provide.

So from an asset allocation perspective I’m looking at the portfolio from a currency exposure viewpoint. That is, ASX + hedged global equities = AUD and the rest Non-AUD (ie country risk protection).

 

Where’s @dunno, I need you.

 

I have been accumulating VGAD in preference to VGS since around that time.

It means I have a dynamic allocation range for my foreign currency exposure based on my LONG-TERM perception of AUD valuation. Comfortable with that.

I would think that somebody that doesn’t want to make active valuation decisions and their primary concern is simplicity might be better off sticking to a static allocation for currency exposure - It is one of those individual call things.

 

Thank you young @dunno. I suspected that would be the case.

As retirees with potentially different timeframes I also think it makes sense from a rIsk management perspective. Although as you say it could be seen as violating the aspect of simplicity. God forbid excluding my legacy holding in PMC that would make our Global holdings a grand total of two ETFs ie VGS and VGAD.

 

The simplicity aspect is not so much the number of holdings – but in making the currency valuation decisions.

Might be better off having a static allocation to hedged/unhedged than letting the allocation float dynamically based on valuation calls. One day once I have perfected slothfulness, I reckon I will switch to static. Probably around 60 AUD : 40 foreign. I feel that ratio is “roughly” right for balancing home country risk and liability matching – but it’s a highly debatable number.

Given a 50:50 local/foreign allocation for asset diversification that would mean a static 10% hedged currency allocation.