adamu wrote: ↑Fri Jul 10, 2020 3:05 am
I'm confused about currency hedging myself.
The objective seems to be to try to keep the performance stable in respect to the local currency. Normally, the value of bonds vary based on the interest rate. But if you add currencies into the mix, then they vary based on the interest rate and the exchange rate. So hedging means that the performance of the bond should be similar to its performance in its own currency, regardless of the exchange rate.
For long term holdings, I wonder if hedging is worth it? You're just trading an uncertainty (exchange rate) with a drag on returns (the cost of hedging). I guess the argument is that bonds are supposed to be the "safe" bet, so we should remove as much uncertainty as possible. If the exchange rate is negatively affecting your stocks, you don't want your bonds to go down at the same time.
Did you see the write-up?
https://personal.vanguard.com/pdf/ISGHC.pdf
Conclusion: For foreign bonds, reduce focus
on yield; keep focus on diversification
Earlier research has established that hedging an
international bond portfolio is an important way to
reduce the risk of currency movements. However,
hedging introduces an additional return stream that
a domestic bond investment does not have, namely
a hedge return, which can be measured and estimated
over the short term. This paper’s discussion has
highlighted four observations about the return impact
of hedging:
• Hedging does not merely produce an investment
without currency return; rather, it represents an
alternative return stream to replace currency return.
• Over the short term, the contribution to return
from hedging has tended to be much less than
the contribution to return from foreign currency
that is unhedged.
• The relative volatility of the hedge return has been
small compared with the price movement of
international bonds, meaning that the diversification
benefits of international bonds should not be
weakened by hedging activity.
• Over the medium to long term, hedging has the effect
of adjusting for differences in market fundamentals,
mainly differences in interest rates and inflation. This
has tended to equalize returns across markets and has
detracted from the usefulness of yield to maturity as a
long-term return predictor.
Based on these observations, Vanguard urges investors
to be aware of the impact that hedging can have on their
international bond portfolios. It is likely that a reduced
focus on the yield of a hedged international portfolio is
warranted. Also of note: Comparisons between yields
across domestic and international markets are not valid,
and we discourage the use of yield differentials in setting
bond allocations. Rather, investors should focus on the
diversification benefits that international bonds can bring
to a balanced, low-cost portfolio.
Vanguard obviously has to avoid making a direct recommendation. It seems hedging is more of a complicating factor then I initially thought.
Perhaps I should by Hedged and Hedged in equal parts?