Don’t bother currency hedging your equity portfolio. Especially not if you live in the UK. It’s what old-timers call a Texas hedge: one that increases both risks and costs.
Of course, with Sterling plunging in the past few days – for what, if I was being polite, I’d describe as idiosyncratic UK political reasons – my opinion might smack of recency bias.
But I’ve been banging this same drum for decades.
Later on I’ll recall what happened during the Covid pandemic, safely insulated from the heat of the latest made in Westminister mayhem.
But first a few basics.
What is a currency-hedged equity portfolio?
You’re a UK-domiciled investor. You measure your portfolio’s return in British pounds (GBP).
Let’s say you buy a London-listed ETF that tracks the S&P 500. (Ticker: IUSA, for instance).
The share prices of companies in the S&P 500 are denominated in US dollars (USD).
You’ve therefore now got two exposures: to the prices of the stocks, and to changes in the GBP/USD exchange rate.
If you want to eliminate the exchange rate risk, you can buy an equivalent currency-hedged ETF. (Ticker: GSBX, say). This ETF uses a financial instrument (a derivative) to bet against the USD.
As a result you now only have exposure to the price change of the stocks in the S&P 500, not to the currency as well.
Why do some people claim hedged is less risky?
Well, that’s just common sense, surely. Taking one risk must be less risky than taking two risks added together?
Right?
You’ll also hear: “Your future liabilities are in GBP. So you want to hedge all your cash flows back into GBP”.
If you accept these arguments, then the debate is whether the reduced risk is worth the extra expense of the currency hedging. Obviously the currency hedges cost money, because you don’t get owt-for-nowt. But it’s cheap – only costing a few basis points a year.
However I’d argue you really shouldn’t currency hedge your equity portfolio because of:
- The existence of holistic ‘natural’ hedges
- The relationship between currency values and inflation
- The correlation structure between currencies and equities during bad times
Reasons (1) and (2) apply wherever you live.
Reason (3) depends on the correlation between your currency and global equity markets. This one depends on where you live.
Natural hedges
Your own home, the Net Present Value (NPV) of your earned income, the NPV of your state pension, and any defined benefit pension rights are all denominated in your home currency.
Most of your unhedged equity portfolio probably won’t be denominated in your home currency. But your portfolio is also likely a lot smaller than those other assets.
In that case I’d suggest you actually want exposure to other currencies. This is more diversifying, and holistically, it reduces risk.
By contrast hedging reduces your level of diversification across all your assets. And, as you probably know, diversification is the only free lunch in finance.
The other natural hedge is within the equity portfolio itself.
Hedged products hedge against the listing currency. But this is often not the actual economic exposure.
For example I’d argue a US company which earns most of its profits overseas is not really a US dollar-exposed company.
For the same reason, the FTSE100 usually goes up when Sterling falls. That’s because most of the FTSE 100’s earnings are actually in USD.
Inflation
The relationship between currency movements and inflation also causes a natural hedge.
Since the UK imports pretty much everything – including labour – a lower value of GBP increases inflation in the long run.
But at the same time, a lower value of GBP would boost the value of your (unhedged) foreign portfolio. Just when you’d want it to offset higher inflation – how convenient!
What about the other way round?
If GBP rises, then sure, the value of your foreign portfolio will fall. But inflation will be lower in the future thanks to the stronger pound, and the value of your house, salary, and so on will be higher in terms of global purchasing power.
Correlation: risk-on / risk-off
Is your home currency a ‘risk-on’ or a ‘risk-off’ currency?
If your home currency is a risk-on one, then its value will rise when times are good and fall when times are bad – just like equities usually do.
Hedging can therefore increase the size of your portfolio drawdown1, because this is a Texas Hedge (one that increases risk).
I’ve written my article under the assumption that most Monevator readers live in the UK, which has a risk-on currency.
If you live in a risk-off country like Switzerland or America, well done!
Pandemic case study
To sidestep any arguments around those ‘idiosyncratic politics’ I mentioned earlier, let’s look at the Covid pandemic rather than dwell on what currently ails the UK.
Cast your mind back to the height of the Covid market panic. It is mid-March 2020, and hedge fund manager Bill Ackman is crying on CNBC.
What is Sterling doing? This might jog your memory:
As a UK investor in global equities, what did ‘hedging’ deliver?
Well, measured at the height of the crash hedging your equity portfolio would have resulted in about a 10% greater drawdown. Some hedge!
So there you have it, don’t hedge your equity portfolio if you live in a country with a high risk currency, like the UK.
What about bonds?
The hedging decision is a lot more nuanced for bonds.
The volatility of bonds is generally low (well, until this year, anyway). This means currency fluctuations can swamp bond returns.
Why are you holding bonds? If you’re holding them for the steady drip of income in your home currency, and you just want to observe low volatility in your account – then maybe currency hedging them is the way to go.
But most of us don’t actually hold bonds for income. We hold them because they (usually) go up when equities go down.
That’s what the 60/40 portfolio and regular re-balancing is all about…
Surely going up more, when equities go down then, would be even better?
And, almost magically, if we live in a ‘Risk On’ currency area then we can do just that, by simply not hedging the currency risk of our bonds.
How? In bad times (usually… not always and not right now) when equities fall, the GBP falls, and USD sovereign bond prices rise.
In pounds, hedged bonds rise, but high-quality unhedged bonds2 rise even more (because GBP has fallen).
Which is great because that will give us more money to rebalance into equities.
Like everything in markets and investing, you can’t bank on this neatly happening every time without fail. But that’s typically what we’ve seen in the past.
My vote? Don’t hedge your bonds, either.
King dollar
Personally I skew my liquid investment portfolio towards foreign assets and I never hedge currency exposure. Most of my foreign assets are in USD.
As well as the reasons above for not currency hedging, I also have my own personal biases.
After decades of working in financial markets I just can’t think of GBP – a currency used pretty much exclusively on a small, isolated, increasingly irrelevant island with a yawning trade deficit and a government that applies sanctions to its own citizens and businesses – as real money at all.
To me, there’s only ever one money. And it isn’t the British pound.
Read more unique takes from Finumus in his dedicated archive, or follow him on Twitter.
Sentence seems to trail off at foot of document?
“In pounds, hedged bonds rise, but high-quality unhedged bonds ((I’m thinking of US Treasuries here.”
@Charlie — Oops, thank you! For some reason the temperamental footnote system had borked between editing and publication. Should be all good now. 🙂
Thanks for this Finumus, very timely.
My first thoughts/challenges:
1) I think most of us aren’t interested in the idea of hedging every last penny in perpetuity for our portfolios to the £. What’s appealing at the moment is every currency (not just the £) is hugely weak against the $. History tells us that that typically reverses and so does that not present an opportunity to, say, switch to contributing to an ETF like IWDG until the equity markets and by association the non-$ markets recover?
2) You present the bear case of ‘look at COVID’, but what about the reverse? What if towards the bottom end of the GFC we started buying a hedged global tracker. Then when markets regained their new highs, switch it back to VWRP or whatever? I imagine that would look pretty tasty. Who knows if we’re anywhere near the bottom for equities, but the S+P is already down 21% *nominal* / 30%+ real.
So, ref the above, if we were in ‘average’ times then I’d agree with you, but these are not average times, most currencies are near historic lows against USD, so the case is less clear. I do appreciate though that this goes against the passive mantra of keeping things simple.
3) on the flip side of the coin, our distinctly non average times brings to my mind a greater long term risk in favour of your argument. The ongoing long term depreciation of Sterling. A long term graph only really heads in one direction for our currency, and as you rightly say, the £ is not the king here.
So, in sum, I’m still somewhat undecided what I think. It could be a good short-medium term opportunity to hedge, but I certainly agree with you when we talk about the typical investor for the long term.
As a bit of an aside, I’d probably count as a weird/special case given I have no property and travel almost full-time, so my portfolio is all I’ve got currently.
Though I have to say this factor probably makes me less likely than not to hedge. The idea of Sterling appreciating in the long term to the point where it becomes problematic in that respect seems, umm, fanciful.
I am tempted to dabble for the short-medium term though, I suppose I could argue I’m diversifying on your logic too 🙂 Though when i dabble, I tend to regret it.
Great article. I do think that most here are looking at strategies to capture some upside from the falling £ due to faith in mean reversion and the long term outlook for the UK (we still intend to retire there after all!)
Yes this is a form of market timing / active allocation, but I’ve shifted this quarter’s cash into XDPG (and will probably do so again come Xmastime). It isn’t a significant portion of the portfolio but will either come good (thanks to historical mean reversion) or fail (which means the UK may be Turkey’ed and it won’t matter anyway… how crazy that this is even a possibility).
far_wide curious if you have a tax domicile or are fully “digitally nomadic” – after the kids fly the nest its something I’m tempted to do for a few years…
@far wide, it sounds as though you want to become a currency speculator 😉
The mantra for passive, if there is one, is take market returns and don’t make bets. The reason is that active bets cost money and that cost will be detrimental to long term returns. Seems obvious the pound will bounce back as it has in the past? Dangerous talk. Even if you are right, are you likely to call it right when you want to unhedge?
I am not sure what you mean by normal times as I cannot ever recall such a time. Maybe I could identify a normal time with hindsight!
I wholeheartedly agree with Finimus about currency hedging equities. Never done it and never will. I also agree with holding US Treasuries. I used to do that when I was 60/40, although with the benefit of hindsight I should have held more of them.
Where I think I diverge is now that I hold up to 6 years spending in cash, or near cash, and the rest in equities, I want to take minimal risk with that cash and definitely don’t want currency risk.
In your case, where you are unsure where you may eventually retire/drawdown I think it makes sense to hold foreign, unhedged bonds.
I can see the logic in people who regard themselves as HNW wanting to measure their wealth in dollars
I can see the logic of people who dont have a home in the UK (or anywhere) measuring their wealth in dollars
But for most people living in the UK not really going abroad very much … I don’t see the need to measure my wealth in dollars
(… and yeah I know c. 75% of currency depreciation finds its way into inflation eventually…)
The constant allusion to America as a signaller that the speaker/author is “in the know” is one of the fatal weaknesses that has got us to where we are now
Very interesting article and point of view. My only criticism might be why couldn’t you have written it 6 months ago ( oh, and made sure I read it) !
Thanks.
I completely agree.
I’ve never hedged anything. Equities or $TIPS or if I had any global bonds. I still wouldn’t hedge now not withstanding the points above that the £ is historically near a low as currency movements are not predictable. I’d just be more inclined just to buy £ denominated assets where you get the exposure – GILTS / FTSE 250 / Small Cap etc
And I’m very exposed to the £ through property, earnings and also the decisions of the govt, which is a increasingly relevant point.
Emerging economies / banana republics / Declining economies / UK – the population hedges their exposure by having something else than the national currency. Otherwise the risk is you end up with a lot of worthless paper.
I recall getting some abuse a couple of years ago for not hedging my $TIPS which I never really understood why not withstanding all the arguments! Great article.
@Mr_jetlag, I’m still tax resident in the UK. The UK gov website has all of the info (which does get potentially quite involved) in ruling yourself in/out of that, and the only other thing to be mindful of is not ruling yourself in to where you’re travelling to as well (most often by spending >183 days a year there).
@Naeclue you’re frankly probably right, although just because it’s the usual option doesn’t make taking an unhedged tracker a entirely passive choice just as investing in a market cap weighted global tracker doesn’t either.
Above said, I do think that the general strength of the $ in times of market stress is a bit of a special case. Put it the other way round, when the economy recovers and stocks recover, can you really imagine the $ staying as strong as it is relative to all currencies? It’s not even convenient for the US for it to be so long term I believe.
Where I totally agree with you is my/anybody’s ability to time this well and a general feeling that this is basically trying to be too clever. Which as I alluded to earlier, has rarely served me well. I also don’t believe in Sterling’s particular case of it’s long term prosperity.
Re: bonds, I’m actually a bit surprised that Finumus landed on the side of unhedged. I thought the general consensus (even in an article here somewhere?) was to go hedged given that they’re meant to be a less volatile dampener in one’s portfolio. Though of course that concept sounds utterly ridiculous now in light of recent events admittedly.
I don’t recall anyone in these parts advocating unhedged bonds out loud until now though – did I miss the memo?
@Naeclue
Your argument on the passive investment is excellent one. The cap-weighted all-assets global portfolio which the EMH tells us we should all hold – is identical for everyone in the world. It’s not different depending on where you live. Currency hedging moves you away from the global ‘market’ portfolio – and is therefore an active bet. If you believe the EMH (and most people should behave as if it’s true, whether they believe it or not) then you shouldn’t currency hedge.
Perhaps everyone could agree on something like
“Don’t Currency Hedge 66% of Your Total Position”
(on average?!) as a title?
if you were holding (66unhedged,34hedged) at the start of the
year, you might be at (63unhedged,26hedged) now – so if there
is to be some mean reversion we do want to buy something
in the hedged portion today, specifically?
if you *had to* buy and hold either VGOV or VUTY today, for five years, which?
@far_wide: You write:
Regarding equities there’s no consensus, even on Monevator. I’ve written articles pointing out the virtues of diversification (I link to an ancient one in the article). I’ve also pointed out how you can hedge via ETFs, as referenced by @Finumus. The academic research is a bit middling; I’d say it’s been shifting towards ‘hedge some of your equities, probably not all’. I’ve had a vast article (3000+ words) in drafts trying to unpick all this, but it’s complicated.
It’s worth noting though that (a) much of the academic focus is on the US, and as @Finumus says we have a different flavour of currency with GBP and it’s getting more so and (b) I think it’s fair to say that @Finumus is focusing mostly on the short-term (/drawdown) advantages here, although there’s an argument for not bothering to hedge equities long-term, too (basically the underlying economies respond to a weaker economy etc, inflation enters the picture, and this naturally balances things out in time).
Re: Bonds, I agree the consensus is to hedge overseas bond exposure presuming it’s in your ‘high quality bonds’ bucket (as opposed to a riskier speculative hold like, for example, EM debt).
I’m very happy to read a well-articulated non-consensus views though, especially from @Finumus!
Like everything in investing it’s down to your personal aims and proclivities, and which risks are most important to you.
Finally, as I always remind people it doesn’t have to be all-or-nothing.
Half persuaded? Then hedge half your Treasuries. Etc. 🙂
Oh, I’m fully bought in to the efficient markets hypothesis – I stopped cherry picking divi shares a decade ago and gradually moved everything to 80% VWRP – but life isn’t an economics textbook, investing is never truly emotionless and we aren’t robotic rational actors.
Given the fear and uncertainty this week seems to be reaching GFC-like proportions, it’s understandable that some want to make a change to their investing behaviour. In the larger scheme of things buying hedged ETFs with net new money is a mild change with potential upside, as long as you’re not selling out of existing positions at a loss.
Already acknowledged this above, but this is probably a 3 out of 10 on the “naughty active antics” scale. My meme stock play portfolio on the other hand…
@Meany – I like TI’s take, “hedge some of your equities, probably not all”; it’s like my current heuristic of “eat mainly plants and much less meat” which is far easier for me to follow (eg 3/5 meatfree days this week) than a strict veg / vegan approach.
Great post. I’ve never currency hedged anything mainly due to laziness and ignorance and also an intuitive feeling that GBP being a risk on currency might mean hedging could backfire. For once, inertia pays off!
Anyway. Slightly off topic but I (living in England) have a bunch of US$ in HSBC and it is currently earning 0% interest. This is obviously great for HSBC and not so much for me. I’ve decided to buy some US treasuries now that yields are looking tastier. But: HOW? I use Iweb for my equity investments (but they don’t accept $ payments in, so I’d end up taking *two* whopping FX hits buying and more on selling).
I’d therefore like to find a way where I can send the US$ directly to someone reputable and they give me US treasuries directly back, reducing my costs, and allowing me to enjoy the delicious interest.
Never having directly bought any kind of bonds before, would they automatically reinvest the coupon proceeds for me if I asked nicely? Or would they insist on sending it to my HSBC dollar account? Or that I fly to DC to collect them from some giant Fed building stuffed with freshly milled dollar notes??
Pardon my ignorance 🙂
@Jimbob Not a recommendation obviously. But in your situation I’d open a Interactive Brokers account, wire the USD to them, and then buy a USD denominated US Treasury ETF on the London Stock Exchange (you likely can’t buy US listed because of PRIIPS). You’d need a decent wedge to make this worth while. You can DM me on twitter if you want to know more.
I’ve been thinking about moving half of my global equity provision to IGWD or the cheaper dist version for a few days now, so this article is timely…
I generally don’t buy currency hedged versions of funds/ETFs as from previous experience the hedging cost does add a drag, and currency speculation is a bit of a mugs game.
That said I did play the Covid crash bounce with a GBP-hedged global equity tracker because the pound was at near historical lows in March 2020 (surely it could never, ever go lower than that right??), but then dehedged later in 2020.
This time round I don’t want to come out of all my UK and global equity dividend trusts and ETFs, and the FTSE100 has been self hedging to a degree anyway. Plus I am not exactly overly heavy in US assets anyway.
I certainly don’t want to buy any additional US assets with my weak pounds at this stage.
Amongst other things on the shopping list I am going to buy some iShares EMHG though, which is $ denominated EM bonds hedged to GBP.
Down 25% YTD, the 8%+ Average YTM is now tempting to add to an income portfolio, even though I’m fully aware yields could blow out further and the fees and hedging costs will probably trim a little of that return.
If GBP/USD was in the middle or top of its trading range of recent years, say closer to 1.30 or more, I’d be more inclined to go for the unhedged version of this ETF, knowing that any new crisis would usually kick the pound more than the dollar.
But at least for now it seems less risky to get the GBP hedged one until our currency stabilises and strengthens when a more financially astute chancellor such as Rachel Reeves or Diane Abbott takes over.
Maybe the credit rating of the EM bonds will soon be higher than gilts anyway.
Thanks for a very useful article.
Noddy question alert – how do I tell whether a fund is currency hedged or not? Example ISIN – GB00BHZK8D21 – states in the factsheet that:
‘Currency hedging may be used which aims to reduce the effect of such
changes. However, the effects may not be completely eliminated to the
degree expected’
> You’ll also hear: “Your future liabilities are in GBP. So you want to hedge all your cash flows back into GBP”.
That sounds like “I and my suppliers don’t buy anything from abroad.”.
I might not find that easy to believe.
@Ben Swain
Most funds which invest overseas will do some currency hedging as they see fit. That fund is not hedged – the key para is the previous one in the factsheet:
“The fund may invest in instruments denominated in currencies other than
the fund base currency. Changes in currency exchange rates can
therefore affect the value of your investment.”
In general hedged funds will include “Hedged” “Hdg” or at least “H” in the description, and usually the currency they are hedged to e.g. GBP.
I’ve long been tempted by this unhedged US treasury move. As Finumus says it often works out, but there are times when it backfires:
https://monevator.com/do-us-treasury-bonds-protect-uk-investors-better-than-gilts/
I think it requires you to be pretty bold and nimble when it comes to rebalancing as much of the currency gain is given up when risk comes off. Except it’s often not so obvious when risk is off. So this play is not for everyone.
@ Finumus – I’ve read before that the UK’s correlation with risk on / risk off is prone to moving around. Though perhaps we’re cementing our status a little more thoroughly now. What I really wanted to ask you about though is the risk of a crisis emanating from the US. I guess we’re a little more relaxed now but if Trump had won a second term it’d be a more salient question. It’s hard not to think of the US as an unassailable guarantor of global capitalism but… what are your thoughts on the political fragility of the US undermining its safe haven status?
@The Accumulator
On the risk of a crisis emanating from the US? My best guess is that even if there is one, it will still cause people to pour money into USD in the short term. Of course if it becomes clear they are monetizing their deficit it may make their bonds (and therefore $) less attractive. Who knows?
Great article @Finumus. Really good timing, as I’ve been thinking a lot about this recently. Certainly would not be want to be hedged in anything if we go ‘all out Argentina or Venezuela’…
For my Bonds / Cash in my tax wrapper portfolio, I have only (unhedged) TIP5 & FEDG at the moment. Considering changing my FEDG back to GBP in anticipation of a GBP bounce… but risky game.
I’ve been swapping a significant proportion of my portfolio to ‘Systematic Trend Following Funds’ recently. Struggling whether these should be hedged or unhedged. Any thoughts on that ?
Very timely article
Ive got a linker maturing [gulp! value is 6% of my total portfolio ] and plan on adding to my equities with the proceeds, so “new money” to go into the stock market. But with the £ weakened against the $ im nervous of buying global equities and thinking IWGD would be better option for this particular lump sum of new money.
But then TA will be adding new money soon to the slow and steady portfolio …
looking for some thoughts from wiser ones than passive investor me?
thanks in advance
Off topic n00b question if I may: given falls in prices of bonds (and rise in yields) why are e.g. LS20 (1.39% – 31 Aug 22) and VG Global Bond Index Funds (1.5% – ditto) yields so low?
Is this because the errm, old bonds (technical term) need to expire before they are replaced with newer higher yielding ones, and if so, as I am in accumulation for around the next 13-15 years (hopefully), will these funds only ever capture a sliver of e.g. the 4% yield that e.g. 10 year gilts currently offer (whether because yields fall or rise from here)?
Aiming for around 15% exposure to bonds via LS20 as part of an FI bridge to 2 DB pensions.
I hate trying to get my head around bonds. Grateful for any responses. 🙂
@ Dawn – I wouldn’t hedge my equities. I don’t think I can time the currency markets any more than I can time the stock market. If I bought a hedged fund then maybe I could earn a bit extra if the pound rebounds a little. Maybe I’ll just compound my losses by making the wrong guess.
If the pound does rebound then how do I know when the rally has run out of steam? It’s the active argument all over again but shifted to a slightly different arena. What’s my edge?
@ Zero Gravitas – You’re almost certainly not seeing the yield-to-maturity on the Vanguard consumer site. They have a habit of labelling a number as a yield and then not explaining what it means.
To see the equivalent of the yield you’re seeing quoted in the bond market, tick the ‘Professional Investor’ box on the Vanguard site and take a look at your fund’s yield-to-maturity (YTM).
If this is your fund then it’s showing a YTM of 4.1%:
https://www.vanguard.co.uk/professional/product/fund/bond/9142/global-bond-index-fund-gbp-hedged-acc
@TA Thank you!
@far_wide
“…probably makes me less likely than not to hedge”
Is it just me, or is that very unlikely indeed?
@TA. Thanks. Your right. Makes sense.
“a small, isolated, increasingly irrelevant island with a yawning trade deficit and a government that applies sanctions to its own citizens and businesses”
Ha, yes. My feelings exactly. I took the UK share of my portfolio down to 10% a long while back.
I don’t understand this approach. If you want to be passive surely the correct foreign FX exposure would be a your likely liabilities in those foreign currencies. If I spend say 30% that is priced in US dollars and 20% in Euros, then my portfolio should have 30% exposure to the US dollar and 20% to the Euro.
This is hard to define but seems a better hedge than basing it only on a asset portfolio. I don’t see why if my asset portfolio is 80% US stocks and 20% US bonds that I would then hedge only the 20% in bonds. My portfolio would then be 80% US dollars and I would be taking a big view on Sterling vs. Dollar. I’d be 50% overweight. Surely that is a big active view? If I change my mind and go 50% stocks and 50% bonds, why does my FX exposure need to change?
Thanks for this article, timely and appreciated.
Much appreciated and well timed article – as is often the case with investing “Don’t just do something, stand there” seems to apply.
@SemiPassive I genuinely can’t tell if “when a more financially astute chancellor such as Rachel Reeves or Diane Abbott takes over.” is top tier deadpan or not. Either way it made me chuckle so thank you
An interesting read and as usual plenty of meat in the comments, giving me some concerns about my strategy of reacting to the £’s slide. But, because I believe the £ will recover, I am sticking to my guns and increasing the £ hedged share of my equity ETFs. I will make it 100% hedged if £ goes to parity with the dollar. I will flip back if/when the £ goes to $1.4 and not before. This served me very well in 2016 and 2020 so fingers crossed that I am first, second and now third time lucky.
Interesting stuff.
@Elen – I tend to agree. Saying an investor doesn’t have an edge re speculating on foreign currency movements is of course true, but nonetheless if a (passive) UK investor is investing in VWRL or IWRD with 60-70% in US holdings, he/she is actively choosing a high degree of dollar exposure (loosely ignoring the fact that US companies will have foreign currency earnings). If these holdings increase in dollar value, all good, but if the dollar weakens/pound strengthens then gains are reduced accordingly. Like it or not, that’s surely currency speculation to an extent? Diversification? Maybe.
The opposite is of course also true. IWRD for example is 12% off its 52-week high, whereas the hedged equivalent IWDG is 30% off its 52-week high. IWRD has undoubtedly benefited from a strong dollar, whereas IWDG arguably closer reflects movements in asset prices. Being invested in IWDG makes the currency movement irrelevant and you’ll directly receive any actual asset gains or losses. With IWRD you’re at the mercy of fx rates.
Ordinarily I’d agree that it’ll be swings and roundabouts but we currently appear to be experiencing massive dollar strength. Its biggest quarterly climb in at least seven years on Friday, along with its largest four-month rise since November 2008. In September the dollar briefly touched its highest level since 2002. Obviously we don’t know when or if the dollar will weaken, but you’d maybe think a hard landing US recession and/or the Fed dialling back interest rates when they get inflation under control, would reverse some of that dollar strength.
For the record I’m in neither IWRD or IWDG, but have a lump sum to invest and veering towards the latter. I quite like @Onedrew’s approach of rebalancing between VEVE and IWDG as FX rates shift. Admittedly it’s active, but I’d argue it’s an active decision to accept VWRL/VEVE/IWRD’s currency exposure.
@ Norman – that’s incorrect. The passive position is to hold the market in equities. Specifically, the global equities market in the lowest cost index tracker. That means accepting the market view on relative currency strengths too.
Arguing that an index investor in the UK is taking an active decision because the market is 60% US equities is like arguing they’re taking an active decision because the index is 4% Apple.
If an investor permanently hedged because they wanted to eliminate currency risk from their portfolio as much as possible, I wouldn’t say that was active. I would argue they’re probably giving up certain benefits that Finumus has covered above.
But if you’re switching between hedged and unhedged positions based on a currency market judgement call then that’s an active bet.
We all like to skew outcomes in our favour if we can, so the main consideration is: do you have a good record of making profitable FX trades? If not, and you take the plunge anyway, then just make sure to accurately record the results of your bet.
For the record, I invested in risk factor funds over a decade ago e.g. value, momentum, small cap, quality etc. An activity I fully accept is active.
I’d have been better off sticking with the global index. Though funnily enough the value funds are the only positive thing in my portfolio this year after ten years of being a running sore.
Brilliant article and summary of this commonly misunderstood topic!
But the question still lies for many people, what is the best advice for people following the passive global low cost tracker (where US equities makes up 60%~ of the fund) investing every month?
Is this just business as usual and we should continue with our monthly direct debits or should we hold off for a few months? Baring in mind the pound is still down around 15% this year (even after the recent recovery following the news about the 45p tax coming back)
And does this still apply to people investing lump sums during this time too?
It’s business as usual. Tune out the noise:
https://monevator.com/passive-vs-active-investing/
https://monevator.com/lump-sum-investing-versus-drip-feeding/
https://monevator.com/pound-cost-averaging-the-buy-low-superpower/
https://monevator.com/category/investing/passive-investing-investing/
@Accumulator & @Norman
I tend to agree with @Norman.
If you hold GPx versions veve, iwrd you are not getting the true rise/fall of assets surely, as the USD based etf’s are changed to pounds in their pricing based on USD/GBP strength & weakness as well as the constituant company strength/weakness. The hedged version takes away currency implications so you get the true asset increase/decrease bar tracking. ie cspx usd$ sp500 etf down 17.6% 52weeks, xdpg hedged sp500 down 18.9%. SPXP a gbx priced version of sp500 is only down 6.6% due to strong $. OK so SPXP looks best but if you want to have the most passive approach surely you remove currency implication by hedged gpx priced etf ?
For the record i hold hedged sp500 & hedged dev world global BUT ibtl unhedged 20+ treasury – am looking at position in idtg as durations lengthen towards end of interest rate rises.