RetireJapan

I really wish I could find the report that is the source of what I said above about the practical effects of hedging. I tried to search, but just got... Me saying the same thing here one year ago Will do some more digging later.

adamu wrote: ↑Mon Mar 06, 2023 2:30 pm I really wish I could find the report that is the source of what I said above about the practical effects of hedging. I tried to search, but just got... Me saying the same thing here one year ago Will do some more digging later.

You put the link
https://www.bogleheads.org/wiki/Currenc ... _investors

beanhead wrote: ↑Mon Mar 06, 2023 2:27 pm

Tkydon wrote: ↑Mon Mar 06, 2023 12:20 pm
On the other hand, do you want to bet that the weak and weakening Yen will continue in to the future?
When the Yen was weak, you probably wanted to be in Hedged Global Funds to protect you from the Forex Risk of a (possible) Strengthening Yen in the future, despite what happens to the exchange rate.

Or how about not betting at all?
I can't control yen-dollar rates.

Make a plan and stick to it, and all that...

If you buy the Unhedged Fund or the equivalent Forex Hedged Fund, you are making a bet one way or the other...

sutebayashi wrote: ↑Mon Mar 06, 2023 1:31 pm

do you want to bet that the weak and weakening Yen will continue in to the future?

Does one want to go with the trend, or be a contrarian?

A prefer to be a trend follower myself, and haven’t seen any evidence yet that the trend is substantially going to reverse, although it is something to be alert to (with my speculators cap on mostly).

Personally I would love to see a strong yen policy picked up again by the authorities, but I’m not betting on that.

I want the Yen to Strengthen so that I can buy Foreign Assets at reasonable prices in Yen terms. At the same time, I want the Yen to Weaken so Foreign Assets are worth more in Yen terms...

I think we in Japan are at the mercy of the FED, BOE, ECB, NAB, and all the other central banks who are raising interest rates in an effort to reign in inflation in their countries...

If the Yen is very weak (relative and subjective, I suppose), how much weaker can it really get? I don't know...
The further weakening would improve the performance in a non-hedged fund, and have no effect if the Yen stays where it is.
Any strengthening would negatively impact the performance in a non-hedged fund.

On the other hand, further weakening would have no effect on the performance in a hedged fund, so you would sacrifice any gain from further weakening, and it would have no effect if the Yen stays where it is (hedged or non-hedged).
But, any strengthening would also have no effect on the performance in a hedged fund, protecting you from any negative impact from Forex risk.

The cost is very small on the Weakening Side to protect you from any risk on the Strengthening side. That is what hedging is all about...

It is up to the individual to determine his or her risk tolerance and go either with the Hedged or Non-Hedged Fund...

Is there any data to support that currency-hedging funds are a viable long-term passive approach? For global equities arguments from historic data seem to strongly support unhedged funds as far as I can see.

However, this may not be true for bond, developed or EM.

https://www.justetf.com/en/news/etf/why ... arity.html

<Copy And Paste Warning>

"Currency-hedged ETFs are designed to protect investors from currency risk. They are a simple, cheap and effective way for small investors to access currency management techniques that were once the preserve of major financial institutions.

Currency risk affects you negatively when your home currency strengthens against a foreign currency – reducing the value of your assets held in that foreign currency. That means UK based investors are exposed to currency risk on all non-hedged ETFs that trade in overseas securities.

Currency-hedged ETFs are useful because they remove the uncertainty of exchange rate fluctuations. They sterilise your portfolio against the effect of currency so that your overseas investment doesn’t gain when the pound falls or lose when the pound rises."

https://www.morningstar.com/articles/11 ... -long-term

https://www.investopedia.com/articles/i ... s-work.asp

These explain hedging if you were investing in the US in USD denominated overseas ETFs,
or in the UK in GBP denominated overseas ETFs... The GBP has Strengthened against the Yen as the Yen has weakened over the years, but has recently Weakened against the USD as the USD has strengthened and over the Kwasi Kwarteng - Liz Truss debacle...
So opposite of our side, so the hedge works opposite to JPY denominated overseas ETFs and Mutual Funds...
When the Yen weakens the GBP and USD strengthen...

TokyoBoglehead wrote: ↑Mon Mar 06, 2023 3:14 pm Is there any data to support that currency-hedging funds are a viable long-term passive approach? For global equities arguments from historic data seem to strongly support unhedged funds as far as I can see.

However, this may not be true for bond, developed or EM.

I think most studies are Single Currency - No Foreign Exchange studies.

Unhedged was the way to go for Japanese based Investors in JPY denominated overseas Mutual Funds over the last 15 years as the Yen weakened from 76 Yen to 150 Yen to the Dollar on 21-Oct-2022. A huge part of your gain was from the doubling of the exchange rate alone...

Hedged was the way to go for US based Investors in USD denominated overseas Mutual Funds over the last 15 years as the Yen weakened from 76 Yen to 150 Yen to the Dollar on 21-Oct-2022. Our gain meant a huge haircut for them...

Hedged would have been the way to go for Japanese based Investors in JPY denominated overseas Mutual Funds as the Yen strengthened from 150 Yen on 21-Oct-2022 to 130 Yen to the Dollar at the end of January... The strengthening Yen contributed (130-150) / 150 = Negative 13% to the performance in the last 3 months.

Tkydon wrote: ↑Mon Mar 06, 2023 2:48 pm

adamu wrote: ↑Mon Mar 06, 2023 2:30 pm I really wish I could find the report that is the source of what I said above about the practical effects of hedging. I tried to search, but just got... Me saying the same thing here one year ago Will do some more digging later.

You put the link
https://www.bogleheads.org/wiki/Currenc ... _investors

Found it. Turns out it was specifically about bonds.

Effectively, the hedge return has tended to push
international bond returns closer to an investor’s
domestic market return. As a result, long-term
returns of international bonds, when accounting for
currency hedging, become more local in character.
You can see this result in Figure 3.

https://static.vgcontent.info/crp/intl/ ... return.pdf

adamu wrote: ↑Mon Mar 06, 2023 11:26 pm

Tkydon wrote: ↑Mon Mar 06, 2023 2:48 pm

adamu wrote: ↑Mon Mar 06, 2023 2:30 pm I really wish I could find the report that is the source of what I said above about the practical effects of hedging. I tried to search, but just got... Me saying the same thing here one year ago Will do some more digging later.

You put the link
https://www.bogleheads.org/wiki/Currenc ... _investors

Found it. Turns out it was specifically about bonds.

Effectively, the hedge return has tended to push
international bond returns closer to an investor’s
domestic market return. As a result, long-term
returns of international bonds, when accounting for
currency hedging, become more local in character.
You can see this result in Figure 3.

https://static.vgcontent.info/crp/intl/ ... return.pdf

And it is written from the perspective of a US Investor investing with USD as the Base Currency.

If the US Investor had bought JGBs in 2009 @ Y80 to the dollar, and sold in 2015 @Y120 to the dollar;

In an Unhedged account, they would have lost 33% in Forex Loss in addition to any gain or loss in the Underlying. Big loss...

In a hedged account, they would have made any gain or loss in the Underlying without any Forex Loss... So the JGB in USD with Hedged Yen would have performed exactly the same as JGB in JPY...

If the US Investor had bought JGBs in 2015 @ Y120 to the dollar, and sold in 2022 @ Y150 to the dollar;

In an Unhedged account, they would have made 13% in Forex Loss in addition to any gain or loss in the Underlying. Still a Big loss...

In a hedged account, they would have made any gain or loss in the Underlying without any Forex Loss... So the JGB in USD with Hedged Yen would have performed exactly the same as JGB in JPY...

If the US Investor had bought JGBs in 2022 @ Y150 to the dollar, and sell in the future @ anything less than Y150 to the dollar;

In an Unhedged account, they will make a Forex Gain in addition to any gain or loss in the Underlying...

In a hedged account, they would have made any gain or loss in the Underlying without any Forex Gain... So the JGB in USD with Hedged Yen would have performed exactly the same as JGB in JPY...

Tkydon wrote: ↑Tue Mar 07, 2023 7:39 am

I think you have not accounted for this:

Currency hedging often involves the use of contracts
that effectively “lock in” an exchange rate,
eliminating the volatility of currency movements from
a portfolio. By locking in an exchange rate, investors
are now exposed to the return from hedging.

This is the key insight that I've not seen described elsewhere. The hedge itself has a return/loss, it's not perfect. This is what tilts the returns towards the local currency.

adamu wrote: ↑Tue Mar 07, 2023 9:43 am

Tkydon wrote: ↑Tue Mar 07, 2023 7:39 am

I think you have not accounted for this:

Currency hedging often involves the use of contracts
that effectively “lock in” an exchange rate,
eliminating the volatility of currency movements from
a portfolio. By locking in an exchange rate, investors
are now exposed to the return from hedging.

This is the key insight that I've not seen described elsewhere. The hedge itself has a return/loss, it's not perfect. This is what tilts the returns towards the local currency.

Tkydon wrote: ↑Mon Mar 06, 2023 5:43 am On the other hand, a Currency Hedged Instrument (for a slight cost) moves exactly opposite to the currency change, meaning the Instrument Price Change is (nearly) 100% the Price change in the underlying instrument.

The Hedge is not free, nor perfect. An the Hedge will be put on for the units when they are purchased, so you will have loads of units all hedged at different exchange rates, depending on when they were purchased.


The Hedge Gain will counteract the Forex Loss, or the Hedge Loss will counteract the Forex Gain - Net (close to) Zero...

Tkydon wrote: ↑Tue Mar 07, 2023 10:21 am The Hedge Gain will counteract the Forex Loss, or the Hedge Loss will counteract the Forex Gain - Net (close to) Zero...

Here is the full report that the summary adamu linked to is based on.

The way the hedges are priced depends on the interest rates in both the home and the foreign country when the hedge is made. Thus the hedge return depends on the currency movement and the interest rates in both countries. It is not simply the currency movement like you are making out. It is the latter point which leads to the returns of hedged international bond funds moving toward the returns of the home country bonds.