Hedging against foreign currency risk
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Thread: Hedging against foreign currency risk

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    Member Kropew's Avatar
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    Hedging against foreign currency risk

    Let's say I want to invest in an american company on NYSE with a very long term time horizon. Assuming that I want to limit the risks associated with exchange rates between CAD and USD, what is the best way to hedge agaisnt this risk?


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    Personally, my approach is to go ahead and diversify my holdings between US and CAN currency. Currency diversity IS my hedge.

    There are numerous CAN$ hedged US funds around and in every case the currency hedging is a greater drain on performance than any possible benefit. Most folks on here will advise to just go with the $US denominated versions and not bother with the currency hedged version.

    EDIT: have a look at some of these articles:
    http://canadiancouchpotato.com/categ...eign-currency/
    Last edited by gardner; 2017-03-17 at 01:42 PM.

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    Right. There are approaches to hedge away the currency and make American stocks act as if CAD/USD is fixed at 1.0, but over the last decade or so we've seen that the cost of this hedging is very high. It introduces a performance drag that is very significant and most of us (myself included) don't think it's worth the cost.

    Foreign currency exposure is good. Most of us have too much Canadian exposure, meaning all our exposure is in CAD. If our currency weakens significantly, as it has it in the past, you will be thankful that you have US and other foreign exposure.

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    I agree with the above, currency exposure is a good thing.
    Hidden Content - Working on a $1 million portfolio and $30k per year from it.

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    Quote Originally Posted by james4beach View Post
    Right. There are approaches to hedge away the currency and make American stocks act as if CAD/USD is fixed at 1.0, but over the last decade or so we've seen that the cost of this hedging is very high. It introduces a performance drag that is very significant and most of us (myself included) don't think it's worth the cost.
    Is the cost of hedging really 'very high'? If I look at Vanguard Canadian ETFs, it shows a MER for VUS & VUN both as 0.16%. Same with VSP and VFV, which are their S&P 500 ETFs at 0.08%.
    https://www.vanguardcanada.ca/individual/etfs/etfs.htm

    They both track the US Total Market Index but VUS is hedged whereas VUN isn't. I'm not saying hedging (or not) is the correct thing to do, as I don't know where the currencies are going, but it seems to me like the cost of hedging may not actually be that high - at least for US ETFs.

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    MER doesn't show the full cost of hedging, instead look at total return. Hedging is an imprecise activity because they do this by using foreign exchange derivatives. These have to be traded on the open market, so they involve trading costs, and there's the imprecision of matching the hedging instrument to the current size of the fund.

    Example, XSP (currency hedged S&P 500) vs IVV (the underlying security). If hedging was working perfectly, you'd expect the performance both in the CAD and USD versions to be equal because they hold the same security, IVV.

    XSP: 10 year performance 5.40% ( ... note, til end of Dec )
    IVV: 10 year performance 6.89%

    You can see that the drag of XSP is 1.49% per year. About 5 basis points of that is due to MER differences (unfortunately this has varied over the years which complicates this comparison).

    Even taking into account extra MER on the Canadian fund, that's still over 1.40% annual performance drag due to currency hedging!
    Last edited by james4beach; 2017-03-17 at 04:16 PM.

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    Senior Member GreatLaker's Avatar
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    Quote Originally Posted by EngPhysGuy View Post
    Is the cost of hedging really 'very high'? If I look at Vanguard Canadian ETFs, it shows a MER for VUS & VUN both as 0.16%. Same with VSP and VFV, which are their S&P 500 ETFs at 0.08%.
    https://www.vanguardcanada.ca/individual/etfs/etfs.htm

    They both track the US Total Market Index but VUS is hedged whereas VUN isn't. I'm not saying hedging (or not) is the correct thing to do, as I don't know where the currencies are going, but it seems to me like the cost of hedging may not actually be that high - at least for US ETFs.
    The cost of hedging appears in the fund returns when compared to its benchmark, not in the MER. Another way to look at it is to compare the tracking error for hedged vs. unhedged funds.

    Looking at VFV (unhedged S&P500) 3 year performance. NAV = 17.08%, Benchmark = 17.45%. VFV has returned 97.9% of its benchmark.

    Looking at VSP (hedged S&P500) 3 year performance. NAV = 10.02%, Benchmark = 10.49%. VSP has returned 95.5% of its benchmark.

    The unhedged fund has 2.4 percentage points lower tracking error, much of which is attributable to the cost of hedging. The gap for VUS vs. VUN is not as large, but over 3 years it is almost 2 percentage points.
    Eschew obfuscation. Espouse elucidation

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    If you believe in the company, what's wrong with borrowing the money, in USD$, to invest in the company?

    You get a natural currency hedge out of it, and when its time to sell, you aren't worried about converting the proceeds (except your gains) from USD$. Nor do you have to buy USD$ up-front.

    Over time, if the stock goes up, the hedging becomes reduced.

  10. #9
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    ^ Yes, that's a currency hedge alright. Doubles your downside potential, not counting the cost of paying interest. Borrowing in a currency which is not the same as your income is not a good idea.

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    If possible should hold every major currency of each continent plus bitcoin, gold, silver if rich enough not all gold & silver held in same country. Fiat currencies come & go, With technology advances & it becomes practical to be able to rearrange atoms to make gold & silver then holding them might do much good. Cycles always turn & we could turn away from technology to that of the dark ages.


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