1 Comment 1 Commentby Susan Edmunds
Melville Jessup Weaver (MJW) has released new data which shows that over the 20 years to December 31, the return on unhedged equities was 5.7% per year, compared to 8.4% for hedged equities.
Hedging allows insurance offers insurance against currency moves. Without it, international investments would suffer when the NZ dollar appreciates.
Mark Weaver, of MJW, said the better performance of hedged equities over the past 20 years was because of the difference in interest rates between New Zealand and other countries.
"When you hedge the currency you are effectively leaving your money earning interest in an NZ bank while you are effectively borrowing from say a US bank to buy your shares with. Interest rates in NZ are higher than in the US due to the risk premium from investing in NZ. Even now we have the NZ OCR at 2.5% and the US Fed rate at 0.5%, a difference of 2%. Over the last 20 years the difference has been between 2% and 3% per annum and explains the high figure you have of 2.7% [difference between hedged and unhedged returns]," he said.
"It is sometimes referred to as a free lunch. Some funds adopt a policy of being 100% hedged for global shares on the argument that you cannot time the currency and so you lock yourself into a long-term pick up of say 2.5% per annum."
He said advisers did not have a good understanding of how to use hedging in their clients' portfolios.
"I think they like to try to try to time the currency. At the moment with the NZD having fallen being 0% hedged looks good. But long-term most investors would be better off with a 100% position. If you do have some exposure to foreign currency and the US$ in particular you do have the positive outcome that when global markets suffer a fall the US$ tends to strengthen and the NZ$ fall. So being unhedged acts as a cushion in this case. I think the advisers are largely responding to how their clients would like their money involved and the clients have an expectation that you can make money on FX trading."
John Berry, of Pathfinder Asset Management, said advisers should consider and articulate their hedging strategy to their clients. "If an adviser uses a fund manager for global equities then understand their hedging strategy - does it align with what you want? How may it impact on returns? How is currency used to manage risk?
He said: "It is hard, if not impossible, to predict currency moves over a short time horizon. But advisers must take a medium to long-term view into account when constructing portfolios. The importance of currency and its impact on risk and return cannot be ignored. If your client started with $1000 in global equities 20 years ago, would they rather have $3030 or $5,018 now? Currency matters."
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Over the past 20 years the NZD has improved marginally against the USD (3.60%), the Pound (6.40%), and Aust dollar (5.91%). During this time the Kiwi has performed significantly against the Yen (24.10%), and poorly against the Euro (-33.85%). Throughout the past 20 years (depending on the date of entry) the NZD performance figures against all of these currencies have ranged up to -47.81% (Euro Jun 1997). So why would you expose a client’s portfolio to an offshore currency?
The diversity reason must be at the top of the list – as other currencies can provide significant portfolio diversity than being fully exposed / hedged to a currency representing less than 0.30% of the world’s economy. To fully hedge the offshore equity component of a portfolio to the NZD is tantamount to suggesting that the NZD is the preferred currency when compared to the rest! I get it that this logic applies to offshore debt exposures – but question why any offshore equity exposures should be hedged at all (surely the cost of the exercise will strip out any benefits alone). Aside from this, the performance analytics of a fully hedged offshore equity exposure change dramatically when compared to an exposure to the underlying currency. Unfortunately these are often tortured to support the interests of those who profess to have an understanding of currency markets.