Pros/Cons for VGS or VGAD

Discussion in 'Shares & Funds' started by PKFFW, 10th May, 2020.

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  1. PKFFW

    PKFFW Well-Known Member

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    Our plan was VAS outside Super and VGS inside super. However, for a number of reasons, we are now considering adding international exposure via an ETF outside of Super. So I wanted to get some thoughts and definitely not any advice on the hedged Vs unhedged issue.

    I understand that if buying consistently over the long term hedging versus unhedged is likely to be a wash or even favour unhedged due to lower fees. However, my wife and I would build our position over the next 2 or 3 years max and I'm not so clear on how it would work when building a position relatively quickly and then not adding to it.

    Does the "all comes out in the wash" thing apply in that sort of situation? Or does hedging make sense when taking a one off-ish position in a situation where the AUD may rise over time?

    Please help me understand. :)
     
  2. Nodrog

    Nodrog Well-Known Member

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  3. The Falcon

    The Falcon Well-Known Member

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    Do you have a view to AUD/Hedged vs Unhedged across portfolio/s overall? This should inform your decision.
     
  4. PKFFW

    PKFFW Well-Known Member

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    Not really no. I'll be completely honest and state the issue is sort of beyond my comprehension mostly. I want Aus/Int equities exposure to be close to 50/50 but as for hedging.....

    In short I had made the decision to start buying VGS outside of Super to increase Int exposure and then it just popped into my head that the AUD is pretty low right now and I wondered if that is likely to have a big impact.
    Thanks for that @Nodrog I had forgotten all about that thread.
     
  5. Pleep

    Pleep Well-Known Member

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    Here's my favourite insight from that thread @PKFFW, reminds that the hedging decision is not worth losing (too much) sleep over..... Credit to the wise soul who summarised their takeaways from an interview.

    Think long term.

    Working on a return of 10% pa compounded over a decade gives 160%.

    If currency went from 75 - 85 cents in the US dollar over that decade it would take off 13% from that 160% investment return.

    Currencies don’t compound, they’re a one off adjustment whereas earnings and stock returns compound over time, and people miss that.

    Measured over a reasonable period of time currencies do not have an enormous impact, they pretty much wash out during those periods where the natural ranges of these currencies are.

    If you’ve got a portion of your portfolio hedged to the $US and we get a major stock market correction the unhedged currency tends to provide greater protection. It’s a diversification and hedge in your portfolio because the Aussie dollar tends to fall during major economic events in the world, and when it falls the value of your global assets goes up.

    There are points in time where the Aussie dollar falls very precipitously and it could be that if the currency stabilised at 65 cents to the US dollar it could make some sense to hedge part of your portfolio.

    Mgrs often offer hedged versions of their funds. So if investors want to think about adding a little bit of excess returns to their portfolio when the currency falls below the historical norm which averages around 75 cents to the US dollar, they should think about switching part of their offshore investment into a fully hedged version of the product. However tax consequences need to be considered if they’re having to realise investments and realise tax.

    But over the very long term, and it fluctuates a bit, it’s the compound investment returns that really matter. Whether the currency is 65 cents to 85 cents isn’t that material. Maybe the variation around the median is 12 or 13% compared to maybe looking at 10% pa which is a realistic target to aim for if you’ve got good investments in your portfolio for the long term which is 160% over a decade!
     
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  6. The Falcon

    The Falcon Well-Known Member

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    If you want to run 50/50 you might want to consider hedging half of your international exposure which will give you unhedged weight of 25%. From memory you are in retirement phase where you would normally prefer a higher hedging level. Long run (30 years) AUD average is around 0.76 but that measure is probably less useful than it seems.
     
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  7. PKFFW

    PKFFW Well-Known Member

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    Not quite in retirement phase yet but (baring catastrophic events) less than 4 years away now. :)
     
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  8. SatayKing

    SatayKing Well-Known Member

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    I'm sure those can be arranged. Working on it.
     
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  9. dunno

    dunno Well-Known Member

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    Hi @PKFFW

    I'm building my international exposure over a decade or so which makes me more aware of the exchange rate whilst building than if I just held the same asset allocation over a life time and built over multiple cycles.

    This is the matrix of how I think about International Diversification.
    upload_2020-5-11_13-40-40.png

    I have a bit of a custom chart I use to monitor A$ mainly for other purposes, but it also informs my VGS v VGAD decsion. On my measure we were recently furthest below trend since float hence I'm buying and have been for a while VGAD over VGS.

    upload_2020-5-11_13-30-54.png
     
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  10. PKFFW

    PKFFW Well-Known Member

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    @dunno thanks for the reply, it helps me clarify it in my mind.

    Just to make sure I understand the detail correctly;
    Firstly, the further below the nearly horizontal blue line the lower the AUD is compared to its historical average value, is that correct?

    Since the AUD is significantly below its historical USD value, it makes sense to control the "rising AUD" variable in your table above, with its negative impact, by hedging. The positive or negative impact by under or out performance will be the same either way. (disregarding issues such as MER, tax, individual circumstances, etc)
     
  11. dunno

    dunno Well-Known Member

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    Yes, the further below that nearly horizontal straight line the weaker the A$ is from a historical perspective (don't forget the disclaimer that the past may not represent the future)

    Beware my chart is not just a USD/A$ chart. It considers TWI amongst other things to give a broader measure of A$ performance.

    And Yes, the impact of relative performance of the Aus market is the same for both hedged and unhedged. Hedging simply negates the currency impact. Turns that double negative where Aus market and currency both outperform at the same time into a single negative but you give up the double positive of falling dollar and underperforming Aus market, the sweetness of the double positive can be seen in holding VGS recently where it diversified the market impact from Covid nicely. But holding VGS during a commodity up cycle will give rise to the double negative.

    Its hard to ignore that the rest of the world largely sees us as a Commodity trade.
     
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  12. Nodrog

    Nodrog Well-Known Member

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    Perhaps it depends on the main purpose for holding global equities. If performance is the main reason within a given timeframe then hedging takes on greater importance. However if it’s protection against home country risk then unhedged would be preferred. Of course one can hold a combination of both to meet a desired outcome.

    As mentioned the Covid crash demonstrated unhedged VGS working nicely as expected given the A$ is considered a risk currency. Yes VGS will be hammered during a commodity up cycle but the ASX will then likely be going gangbusters. Hence from a correlation perspective the simple combination of VAS / VGS seems to works together nicely.

    But there’s other factors such as the overall exposure to A$ vs other across the entire portfolio including asset classes other than shares.
     
    Last edited: 11th May, 2020
  13. Ross36

    Ross36 Well-Known Member

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    These are the reasons I like the idea of unhedged over hedged for my situation specifically. My thoughts are that living in regional QLD we are tied to the commodity cycle with our jobs and house prices inherently linked. The role of VGS for me is to diversify away from that. If/when we get our next commodity supercycle - massive global infrastructure spending post covid to create jobs maybe? - I'd guess that house prices and local shares will outperform VGS but I won't be worrying about it. In Lars Kroijer's book and the podcasts he does do a great job of explaining why unhedged international shares are so important as your diversifier away from your job and housing.

    I must say though that a 50/50 VGS/VGAD split with contribution rebalancing is compelling. Ride that mean reversion wave.
     
  14. PKFFW

    PKFFW Well-Known Member

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    Good points.

    My main purpose for international equities is as a diversifier away from the Australian market as protection from Australia going down the shitter over the next however long. Tax considerations with the mumblings of franking credit refunds being axed is also on my mind. Home country risk, while something to be considered, I don't think is a significant issue in Australia. Performance also isn't a huge factor, I'll be happy with something near the long term average or even just a little above inflation will be enough for me. (Yes, as my wife often tells me, I'm easily satisfied! hahah)

    I like the idea @The Falcon put forward of 25% VGS and 25% VGAD but I also like the pure simplicity of VAS/VGS. I guess my last option could be VGAD for now and when I see the AUD get somewhere near 70-80c US start in on VGS and just end up with 3 ETFs rather than 2. Maybe I'll come out ahead that way and maybe I wont but I don't think I'll come out too far behind either way.

    ETA: Meant VAS/VGS when I wrote VAS/VGAD so I fixed it.
     
    Last edited: 12th May, 2020
  15. Burgs

    Burgs Well-Known Member

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    Some great comments.
    Just had a look at the performance of the wholesale versions as the data is for a lot longer than the ETF versions as follows:

    Vanguard International Shares Index Fund - inception since 6 June 1997
    Total return is 6.21%
    Benchmark is 6.16%
    Benchmark MSCI World ex-Australia (with net dividends reinvested) in Australian dollars Index

    Vanguard International Shares Index Fund (Hedged) - inception since 2 August 2000
    Total return is 5.21%
    Benchmark is 5.29%
    Benchmark MSCI World ex-Australia (with net dividends reinvested), hedged into AUD Index

    Total returns are calculated after allowing for management and transaction costs.

    There is a lot of data that can be downloaded and analysed, but for roughly 20 years of data, there is only 1% difference in performance just looking at the total returns.
     
  16. Ross36

    Ross36 Well-Known Member

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    And I dare say that a lot of that difference is due to the start dates: unhedged in the middle of the massive tech boom and hedged right at the peak of it. That hedged fund inception date was a cracker - right before the drop in the US index and a further decline in the Aussie dollar!
     
  17. Nodrog

    Nodrog Well-Known Member

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    Just posted this in response to a post in the LIC thread but it really belonged here:
    I must admit I was a reluctant holder of VGAD. I really don’t like it at all. Partly because it goes against simplicity but also although it’s a behavioural factor I dislike the lumpy, erratic sometimes non existent cash distributions. I understand they sometimes end up on the capital account so just sell some shares but still it’s not how I’m wired. I’m sure you understand this @Islay:).

    Quite frankly rather than add to VGAD anymore when the A$ is very low I simply add to VAS / old LICs accepting that they may end up overweight in the short to medium term. So be it, when the A$ is at neutral (65 - 85) or above then focus will be on getting VGS back to desired weighting.

    I’d actually prefer not to invest in Global equities at all but only do it to provide some insurance against home country risk. I allocate the minimum amount that let’s me sleep well at night. So given it’s really about “insurance” and NOT short to medium term performance concerns that negates any reason to hold “hedged” global equities (VGAD). Additionally total Global exposure is a maximum of 35% excluding cash, PSS Super DB pensions and PPOR all in A$. Hedging becomes increasingly more important when global exposure gets over say 50% of ALL A$ assets.

    The above was part of very recent final simplification decisions in case some are wondering why some change to past actions. So VAS, VGS, a few older LICs and PMC (wife likes some franked income from Global). That’s it, any wonder I’m finding investing increasingly boring lately.
     
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  18. dunno

    dunno Well-Known Member

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    A couple more years to kick your lic habit and you'll be able to change your nick [email protected] and preach simplicity for the next 36+ years:)
     
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  19. Nodrog

    Nodrog Well-Known Member

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    He he. Yes the @eromiral_rolyat approach could perhaps be considered the ultimate goal in that regard. Although never the Bonds, instead cash / TDs for liquidity and a little extra perhaps for SANF if one felt the need. Although @eromiral_rolyat does accept TDs (CDs) as a substitute for Bonds from memory.

    By geez investing and learning about oneself is one hell of a journey. Accepting the simplicity of it all has been one of the most difficult aspects. Still not perfect but given the wife’s wishes and CGT issues it’s a big improvement.

    @Redwing was the local hero here in regard to the @eromiral_rolyat approach but even his reputation has been tarnished by falling victim to complexity when adding global REITs to his portfolio recently:D.
     
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  20. PKFFW

    PKFFW Well-Known Member

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    So for anyone interested, here's where my thinking is at.

    Due to a combination of past investment decisions, what is available inside our Super fund, and what we are likely to invest over the next 3-4 years before retiring, we will end up with a portfolio approximately 60% VAS and 40% International equities. Close enough to our goal of 50/50 and frankly, the best we can do really.

    Being close to our planned retirement, SORR is on the mind and currency risk only adds to that. That's not such a concern with our current VGS holdings because they are inside Super and we wont be able to touch any of it for 10 years after retirement, by which time the SORR risk will be reduced.

    So, with the AUD well below historical levels, currency risk posing an increased SORR risk, and murmurings of franking credit refunds being axed, I think it makes sense in our particular situation to invest in VGAD.

    Speaking of franking credits, a question for @Nodrog and @dunno , you each mentioned the tax implications of owning VGAD outside a low tax environment such as Super. Could you elaborate on that?

    With our expected retirement income, my wife and I will be in a "lowish" tax bracket and would expect a franking credit that more than covers the tax payable. I assume the excess credit could be used to offset tax implications of VGAD, at least to the extent that any excess credit remains.
     
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