RetireJapan

fools_gold wrote: ↑Fri Jul 10, 2020 6:09 am Kanto, you might also want to take a look at p.6. (my bold)

"This result is seen in Figure 4, which shows that the impact of hedging across markets has resulted in a hedged international government bond investment with an average annualized return that is closer to the experience in an investor’s domestic market. For each country in the figure, the orange box—which represents the return of the international bonds themselves plus the impact of the hedge return—tends to be closer to the return of the investor’s domestic market (in green) than to the return of the underlying international bonds (in dark blue). Previous Vanguard research has demonstrated that investors might expect a similar result when remaining unhedged over the long run, with currency returns producing a similar adjustment for underlying fundamental differences across markets."

Basically, they're saying that
1. over the long term returns for an hedged international bond fund will be similar to a domestic bond fund
2. the returns of an unhedged fund are also likely to be similar

So, hedged or unhedged international bonds shouldn't return much more in the long term for Japanese investors than Japanese bonds. The only advantage they offer is diversification.

Kanto wrote: ↑Fri Jul 10, 2020 7:33 am
Thank you, however I remain a bit confused.

This graph seems to imply historically hedging has NOT been a good strategy for Japanese investors. Or am I reading it wrong?

Hedging.jpg

fools_gold wrote: ↑Fri Jul 10, 2020 2:20 pm

Kanto wrote: ↑Fri Jul 10, 2020 7:33 am
Thank you, however I remain a bit confused.

This graph seems to imply historically hedging has NOT been a good strategy for Japanese investors. Or am I reading it wrong?

Hedging.jpg

The graph doesn't directly compare hedged and unhedged returns, so I don't think you can draw that conclusion. Actually, the dark blue bar shows the returns of international bonds in their local currencies (say dollars and euros).The green bar is the returns of domestic (Japanese for us) bonds in their domestic currency (yen). The hedging return is the light blue bar. So the graph shows that, for a Japanese investor, a hedged international bond fund has historically given similar returns to a Japanese bond fund. The text of the article also makes the point that hedged and unhedged funds should give similar returns over the long term.

Basically what they are trying to say (I think...) is that (1) hedged and unhedged funds offer similar returns, but hedged funds have less short-term volatility; (2) even if international bonds have a higher nominal yield than domestic bonds, changes in the relative values of the currencies means that the actual returns will be the same; and (3) although the returns are similar you should also invest in international bonds for diversification purposes.

If what they say is true, then a hedged fund should be better than an unhedged fund simply because it offers similar returns but with less volatility. However, in the long term neither will return much more than Japanese bonds.

Kanto wrote: ↑Sat Jul 11, 2020 1:45 am
However, I do not think in the long term Japanese bond indexes perform similarly to developed bond indexes.

fools_gold wrote: ↑Sat Jul 11, 2020 4:27 am

Kanto wrote: ↑Sat Jul 11, 2020 1:45 am
However, I do not think in the long term Japanese bond indexes perform similarly to developed bond indexes.

I didn't think so either so I calculated the unhedged returns returns using Vanguard's data.

In 1985, $1 was worth 250 yen.

So, let's say we invest $100 in US bonds and the equivalent (25,000 yen) in Japanese bonds.

Our US bonds returned an average of 7.5% compounded over 28 years, giving us $757.

Our Japanese bonds only returned 4%, so our 25,000 yen has now grown to 74,967 yen.

Now, in 2013 let's sell our US bonds and convert our dollars back into yen. The exchange rate in 2013 was 100 yen to the dollar, meaning our US bonds are worth 75,700 yen. So the returns are almost the same. The reason is that the yen has been steadily appreciating in value against the dollar. It makes sense when you think about Interest Rate Parity.

adamu wrote: ↑Sat Jul 11, 2020 5:14 am

fools_gold wrote: ↑Sat Jul 11, 2020 4:27 am

Kanto wrote: ↑Sat Jul 11, 2020 1:45 am
However, I do not think in the long term Japanese bond indexes perform similarly to developed bond indexes.

I didn't think so either so I calculated the unhedged returns returns using Vanguard's data.

In 1985, $1 was worth 250 yen.

So, let's say we invest $100 in US bonds and the equivalent (25,000 yen) in Japanese bonds.

Our US bonds returned an average of 7.5% compounded over 28 years, giving us $757.

Our Japanese bonds only returned 4%, so our 25,000 yen has now grown to 74,967 yen.

Now, in 2013 let's sell our US bonds and convert our dollars back into yen. The exchange rate in 2013 was 100 yen to the dollar, meaning our US bonds are worth 75,700 yen. So the returns are almost the same. The reason is that the yen has been steadily appreciating in value against the dollar. It makes sense when you think about Interest Rate Parity.

This is a great example. But what about if you had hedged? In that case, your return would have been lower on the US Bond (or, if you lived in a country where the domestic bond performed better, the hedge would have made the US return higher). Basically, hedging adds domestic bias to your international bonds. It seems to defeat the benefit of diversification, so I'm thinking, don't hedge. Not 100% sure though.