International Stocks and Exchange Rate Risk

spider · #1 03-30-2007, 01:03 PM

Lots of folks today buy international stocks to diversify their portfolio. Yet to the best of my knowledge, most people do this without any sort of hedging for exchange rate fluctuations. In fact, I rarely see any mention of this at all. So a couple of questions:

(1) Should a buyer of international stocks generally hedge against currency fluctuations? It seems to me that currency fluctuation is mostly going to add volatility with no increase in expected return. Although, perhaps the strength of the dollar would be inversely correlated with domestic performance (relative to international) and that would actually reinforce the diversification aspect? And of course, if you want to simultaneously bet against the dollar, buying international gives you a two for one.

(2) Assuming you do want to hedge against currency risk, how do you do it? As far as I can tell, most (all?) of the standard international funds/ETFs are not hedged. Is there a standard futures/options strategy for this?

hawk59 · #2 03-30-2007, 01:30 PM

I'm pretty sure that some international mutual funds are hedged. I can't name any but you can find it in the prospectus.

But given that the dollar has weakened over the past few years then the hedged portfolios wouldn't have performed as well, so any new funds have probably been unhedged.

gull · #3 03-30-2007, 06:11 PM

Concentrating positions in dollars does not reduce currency risk. Do you see why?

spider · #4 03-30-2007, 07:27 PM

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Concentrating positions in dollars does not reduce currency risk. Do you see why?

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I don't see why you bothered replying, but I will take a guess at what you are not understanding, though it could be many things.

Let's say you are going to spend almost all of your life in the U.S. and do not intend to bequeath any money to your ungrateful children or anyone else. You are going to spend it all, and all in the U.S.

So you invest some money in an international stock fund knowing you will eventually sell it and spend the preceeds in the U.S. And assume you are neither a bull nor bear on the U.S. dollar vs other currencies (or explain why you don't like this assumption).

Does that help?

spider · #5 03-30-2007, 07:31 PM

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But given that the dollar has weakened over the past few years then the hedged portfolios wouldn't have performed as well, so any new funds have probably been unhedged.

[/ QUOTE ]

Yeah, that's a great point. And along those same lines I suspect that most of the people buying international funds now also want to be short USD.

I'm just wondering if there is any good, fundamental reason for not hedging. If it helps to clarify my general question here, I'm not suggesting one should be either bearish or bullish on the dollar or any other currencies. It's just that the trends have been to separate various types of risk and then let investors combine them as they like (e.g. CDO tranches for different levels of risk, TIPS).

TheMetetron · #6 03-30-2007, 07:36 PM

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I'm just wondering if there is any good, fundamental reason for not hedging.

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It reduces return?

spider · #7 03-30-2007, 07:50 PM

[ QUOTE ]
[ QUOTE ]
I'm just wondering if there is any good, fundamental reason for not hedging.

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It reduces return?

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Yes, sorry, I meant besides that. Thanks for pointing that out. Like any type of insurance there will always be a cost.

But I'm also assuming this would reduce returns by a very small amount (percentage wise) if done by the fund itself (as opposed to the individual investor where transactions costs could admittedly be sizable). But I don't have any particular knowledge of the costs so this could be a bad assumption by me.

SMB · #8 03-30-2007, 11:23 PM

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I'm pretty sure that some international mutual funds are hedged. I can't name any but you can find it in the prospectus.

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Most prospectuses will be overly broad to mention that a fund *may* hedge. Many, if not most, international funds will not hedge, but they like explicitly providing the option to. Sort of like most prospectuses will say a fund can trade swaps or futures, but many don't.

The best places to look are either the quarterly NQ reports, or the (semi)annual financial statements. These will include a full schedule of investments.

One other thing to note is the term of the forward hedges. Are they hedging long duration bonds, short term futures, etc? This can give a better picture of the funds' objectives and strategies.

spider · #9 03-31-2007, 10:48 AM

Well, here a couple background articles (I'm finding "dollar hedged" is a better search term than "currency hedged") that are nice, though I still can't find anything related to the basic pros & cons of this sort of hedging with respect to the basic purpose of diversification.

Yahoo Finance

MarketWatch

NajdorfDefense · #10 03-31-2007, 11:11 AM

[ QUOTE ]
[ QUOTE ]
But given that the dollar has weakened over the past few years then the hedged portfolios wouldn't have performed as well, so any new funds have probably been unhedged.

[/ QUOTE ]

Yeah, that's a great point. And along those same lines I suspect that most of the people buying international funds now also want to be short USD.

I'm just wondering if there is any good, fundamental reason for not hedging. If it helps to clarify my general question here, I'm not suggesting one should be either bearish or bullish on the dollar or any other currencies. It's just that the trends have been to separate various types of risk and then let investors combine them as they like (e.g. CDO tranches for different levels of risk, TIPS).

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1) Some, if not most int'l investors want the ]
currency risk, because they can not do it, or do it easily on their own. [many mutual funds forbid outright fx trading, etc.]
2) Hedging increases costs and fees.