Should you currency hedge foreign stock investments?


Hi, welcome to this video series where answer questions from the readers of Monevator.com. Monevator is the leading finance blog in the UK for personal finance issues. The question in this series comes from Richard who asked whether you should really be hedging currency investments in global equity trackers. This applies to other non-domestic investments too, I assume. Just to explain what I think it means is if you take is an example of someone who invest a hundred pound sterling into a global tracker, it doesn’t quite work this way but a way to think about it is the provider will take this hundred pounds, FX’s the money into various currencies and buy underlying stocks for those currencies. So for example they would take the hundred pounds, they FX it into dollars and among other stocks and buy Facebook shares. This would create a dollar-sterling exposure in which this question should you be hedging this exposure. So on balance I don’t think you should. Now there are a couple of reasons for this. One is actually really hard to know exactly what your FX exposure is. The reason for this is that you know the companies that you’re buying shares in themselves have a lot of FX exposure they might be hedging. You can take Facebook as an example they have operations all over the world, including actually in the UK and it can be hard to know exactly whether what you actually should be hedging. Furthermore, I think something like 50% of the earnings of something like the S&P 500 is actually made outside the US and varried in a wide array of currencies and so that slightly mitigates the issue and could actually mean that your currency hedging is done wrong. The second reason you shouldn’t be currency hedging I think is that it’s can really be quite expensive and as I alluded to quite imprecise. Not only if you go for the reasons I mentioned but also even if you did get the exposure right you should really constantly trading it around this current as shares and the various currencies move up and down. This would lead to very significant transaction and admin costs which would impair your returns in any currency. The third argument why I don’t think you should be hedging your FX exposure is that FX exposure can actually be a diversifier. So if you think of your hundred pound sterling… You’re buying not only exposure to companies in many, many countries but you’re also buying exposure to many currencies. So if there is a shock in your local currency, in this case the sterling, you have the fact that you hadn’t hedged the currency actually means that you’d be better off, and shocks in currency markets tend to move against your local currency is really a shock up. So actually this is not only the cheaper or less cumbersome etcetera but it’s actually probably a good thing to not be currency hedging. The argument for currency hedging is that you should be investing your money in the currency where you eventually need the money and I think there’s some truth to that. But if despite these advantages, the admin, transaction costs, that natural diversifier… and in the of it heart that it’s hard to know what actually what the right exposure is. If despite these facts you still want to currency hedge, I would question whether you really should be investing in as risky an asset as equity markets can be. So I hope that answers the question. My name is Lars Kroijer. I’m a former hedge fund manager who’s written a couple of books about finance and I’m now doing these videos as a hobby. The premise on a lot of my work revolves around how hard it is for the vast majority of investors to outperform markets. I explain what this means and why it’s very likely a hugely positive thing for investors to understand and embrace this premise. You can watch other Youtube videos or read my books if you’re more interested in this. Thanks for watching! There are other videos in this Q&A video series but in any case, I hope you found this one interesting.

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