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Do you hedge currency exposure for foreign stocks?


matjone
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Since other stock markets have been cheaper than the U.S., I have been looking overseas.  But I am concerned about  currency exposure.  On the other hand, I am not so sure that hedging is the answer for me.  The more complex you make something, the greater the chance it will go wrong.  I am sure that you get burned occasionally without ihedging, but if you invest in a lot of other countries I would think it would tend to be a wash.  Tweedy Browne has a paper that more or less confirms this.  Anyway, I have no knowledge or experience in this area so I thought I would get some thoughts from other.  Thanks,

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  • 6 months later...

I was wondering the same thing and noticed that there was no reply. Just wanted to bump this thread.

 

For example, I would like to invest in European/Japanese businesses with profits denominated in their respective currencies, but I'm worried about currency devaluation in the future. What's the best/cheapest way for the retail investor to hedge their currency exposure?

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I was wondering the same thing and noticed that there was no reply. Just wanted to bump this thread.

 

For example, I would like to invest in European/Japanese businesses with profits denominated in their respective currencies, but I'm worried about currency devaluation in the future. What's the best/cheapest way for the retail investor to hedge their currency exposure?

 

Who's currency are you worried about being devalued?  I invest internationally and don't hedge anything.  I've had it hurt me, and had it help me, overall it's close to a wash.

 

I like the Tweedy paper, over long periods of time things do seem to work themselves out.

 

Another perspective, I want some currency diversification if possible.  My job is in USD, emergency savings in USD, investments in USD, if anything were to ever happen to the dollar I'd be screwed.  Having some foreign holdings mitigates this risk.

 

I think American investors are probably the most currency-ignorant investors out there because we have a dominant currency.  This board is dominated (?) or at least has a very strong Canadian contingency, they are all discussing US stocks and are buying in USD.  I'd be curious to know how many hedge, my guess is not many.

 

Most non-US investors don't have enough investment options in their country alone, so they're forced to go abroad for investments.  This forces them to take on currency risk as well.

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Like Oddball I own Japanese stocks thru their exchanges, Great Britain stocks thru their exchanges and German and Italian stocks via the Euro. I personally don't hedge any and have done all right.

  For instance in GB one stock is up 60+% and one is up 2% since I bought not counting dividends. German stock up about 17% not counting dividends, Italian stock up 20%, Japanese one off 15% and one doubled. So in my case currency fluctuations I don't believe have hugely impacted me. Also except for LRE they have all been held for less than a year.

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I think it's the opposite. I am a Dutch citizen and am therefore strongly tied primarily to the Dutch and secondarily to the European economy. Investing in US stocks is a very nice way to diversify I think.

 

Please also note that for multinationals the issue is moot and you'd have to look at the origin of their income. If a stock which is exchanged on a European exchange in Euro's has 80% of its income and revenue from the US market there is far less currency risk (for American's) than for a stock which is traded on the NYSE but has 80% of its cost and revenue in Europe.

 

TLDR; 1) It's a nice way to diversify, 2) The currency the stock ticker trades in is irrelevant

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I think it's the opposite. I am a Dutch citizen and am therefore strongly tied primarily to the Dutch and secondarily to the European economy. Investing in US stocks is a very nice way to diversify I think.

 

Please also note that for multinationals the issue is moot and you'd have to look at the origin of their income. If a stock which is exchanged on a European exchange in Euro's has 80% of its income and revenue from the US market there is far less currency risk (for American's) than for a stock which is traded on the NYSE but has 80% of its cost and revenue in Europe.

 

TLDR; 1) It's a nice way to diversify, 2) The currency the stock ticker trades in is irrelevant

 

TLDR?

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If you're an American and you've invested most of your assets in the U.S. any currency movement should have little impact on you unless the majority of your consumption is imported, so really, no currency diversification is needed in that case.

 

However, say you're an American and you have most of your portfolio invested in an international portfolio, to take advantage of the growth available in those countries, you should probably hedge the currency, no?

 

So, assuming you do need to hedge, what would you do?

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  • 2 years later...

Bumping this thread. For those Canadian investors, with the huge run up in the USD vs. the CAD... anyone thinking about hedging (hopefully to lock in) their gains? Just starting to think about this given that we had another rate cut today could possibly have another one in a few months if things out west don't improve.

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As a Canadian, I've had about 75% of my total portfolio in USD currency and have experienced ~25% gains on the CAD/USD currency exchange since original purchase. I've generally agreed with oddball's post and read the Tweedy paper and others that made me agree it is likely a wash in the long run to attempt currency hedging.

 

With the above in consideration, I also feel like at the extremes of historical currency spreads, it makes sense to start thinking of currency hedging. My general thoughts on the Canadian economy is that we will continue to feel some pain as the oil industry stagnates and the housing boom unwinds at some point. Combine this with a US economy with some tailwinds behind it and it seems like the spread may continue to widen.

 

I'm considering beginning to short sell a USD currency ETF at about 25% of total exposure currently. If the spread widens, I will increase my hedging up to 75-80%. I might get to that level if we get in the 1 USD = 1.45 CAD range. I have no experience doing this in the past, so would be interested in others thoughts.

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The challenge I have for this sort of a hedge is that I don't have a good mental model for currency valuations. It's easy to say "The Canadian dollar was at par, and now it's at 77c, so I should hedge the US dollar."  But then, if instead, the Canadian dollar had gone from 63c to 77c in the same sort of environment, would I now be saying "The Canadian dollar was at 63c, and now is at 77c, so I should hedge the Canada dollar"?

 

What's more, I kind of have a feeling that when the two biggest Canadian real estate markets blow up, it will be bad for the economy, and the Bank of Canada might ease more, which I would think would send the dollar down more.  But I don't have a good model for that, so maybe that's no better than the faux technical analysis model of where the dollar has been.

 

Thus, without a good model for currencies, grounded in math and reasoning, I sit here and suck my thumb.

 

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Futures are by far the cheapest way to hedge currency exposure, simply roll them into the next cycle at expiration. Very cheap and easy to do if you have an Interactive Brokers account.

 

I wonder whether contango might hurt you when rolling?

Would it be sensible to use Forex CFDs for hedging? They seem to be ideally suited for hedging spot risk.

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The challenge I have for this sort of a hedge is that I don't have a good mental model for currency valuations. It's easy to say "The Canadian dollar was at par, and now it's at 77c, so I should hedge the US dollar."  But then, if instead, the Canadian dollar had gone from 63c to 77c in the same sort of environment, would I now be saying "The Canadian dollar was at 63c, and now is at 77c, so I should hedge the Canada dollar"?

 

What's more, I kind of have a feeling that when the two biggest Canadian real estate markets blow up, it will be bad for the economy, and the Bank of Canada might ease more, which I would think would send the dollar down more.  But I don't have a good model for that, so maybe that's no better than the faux technical analysis model of where the dollar has been.

 

Thus, without a good model for currencies, grounded in math and reasoning, I sit here and suck my thumb.

 

Thanks for that Richard. I essentially agree with everything you are saying and is why I can't pull the trigger either. I am essentially anchoring to price in my suggestion, like saying a stocks 52 week low has past so it will guaranteed revert back to the norm eventually. This of course isn't true, but we also don't have to worry the CAD will devolve into a valueless currency. Anyone with a fundamental analysis background should have trouble anchoring to price alone.

 

Hence, at some level of the extremes, your odds will be in favour of reversion to mean. If we were at 1USD = $2CAD, would we agree it may make sense to hedge based on historical currency rates? I am essentially anchoring to random price levels in my example, but I know of no better way when it comes to currency.

 

In regards to using expenses as a hedging concept, it is a good thought. In my circumstances, everything placed into investment accounts is for use 25+ years from now as I can easily live on my work earning streams currently.

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Yeah, I imagine I'd hedge at $1=$2 CAD, just because of the reversion to the mean argument. (Or, if you want to put it another way, I suspect it would give you an extra volatility-adjusted return, the same way that periodically rebalancing a diversified portfolio provides a volatility-adjusted return.)

 

I guess the other option is to learn how to value a currency.  I haven't done that yet, but I suspect that you can do it a "roughly right" sort of way.

 

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Yeah, I imagine I'd hedge at $1=$2 CAD, just because of the reversion to the mean argument. (Or, if you want to put it another way, I suspect it would give you an extra volatility-adjusted return, the same way that periodically rebalancing a diversified portfolio provides a volatility-adjusted return.)

 

I guess the other option is to learn how to value a currency.  I haven't done that yet, but I suspect that you can do it a "roughly right" sort of way.

 

There are ways to do this, like Purchasing Power Parity; however, differentials often last for YEARS. I think it was Stanley Druckenmiller who said that currencies could stay overvalued or undervalued for years and that they have big moves in multiyear trends as it takes awhile for the such long-term misvaluation to correct and because of reflexivity.

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I've read about PPP but it seems to me to be just the outward symptoms of underlying causes. It's like saying it costs x 'rubles' to buy the same as 'x' Canadian dollars. But the cause is far deeper. For example, is the US dollar the strongest currency because it represents - true or false - the free-est country on Earth? Least amount of government meddling? Socialism? etc...

 

 

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I've read about PPP but it seems to me to be just the outward symptoms of underlying causes. It's like saying it costs x 'rubles' to buy the same as 'x' Canadian dollars. But the cause is far deeper. For example, is the US dollar the strongest currency because it represents - true or false - the free-est country on Earth? Least amount of government meddling? Socialism? etc...

 

No it is the strongest currency because it is one of the few countries that is currently not expanding the monetary base. And as long as that is the case, the trend will probably persist.

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  • 4 months later...

The way I think about hedging is really simplistic (maybe too naive), but it's this:

 

Do I want to bet on the things that I understand and can reasonably foresee (which would be the price per share of the company I'm buying) or do I want to make a macro currency bet? For those opting for the former, it should be straightforward. By not hedging aren't you implicitly betting that the foreign currency will either stay flat or go up in value relative to your home currency?

 

I never want to make a macro currency bet, meaning I neither want to suffer due to the foreign currency weakening nor do I want to be unexpectedly rewarded if my home currency weakens - that is fine with me. The only overall benefit I seek is to gain or lose an equivalent % of change in the underlying stock that I purchase. And in order to do that, I need to hedge all the time. The only downside here is the cost of hedging and probably lose out on the upside if my home currency indeed weakens. But I can live with missing out on things that I never foresaw....

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I'm a Canadian who uses the yearly average for currency conversions to calculate values for taxes. The strange thing I'm finding this year is that, with any stocks that I've bought this year and are roughly flat, it makes sense to sell them in December and buy them back in January. This will likely result in an average cost basis for tax purposes of about 10% higher than it would be if I just held, and thereby eventually reduce my taxes.

 

I think it's pretty unusual it happens to this extent.  You really need a big currency move near the end of the year to make it worthwhile playing such games.

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If it's a multinational it depends how much of its revenue and costs it makes in the different currencies NOT what currency the ticker happens to be trading in.

 

Having said that, I dont hedge. First off I dont insure costs I can bear as it will cost money. Second, you're quite dependant and tied to the nation and currency you earn your income in and have your home. It's nice to diversify away from that.

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The way I think about hedging is really simplistic (maybe too naive), but it's this:

 

Do I want to bet on the things that I understand and can reasonably foresee (which would be the price per share of the company I'm buying) or do I want to make a macro currency bet? For those opting for the former, it should be straightforward. By not hedging aren't you implicitly betting that the foreign currency will either stay flat or go up in value relative to your home currency?

With currencies you are always making an implicit bet on something, and it really shouldn't be called hedging because you are either long your home currency or long some foreign currency. It is not possible to have a hedged position with zero exposure.

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