Currency hedging for Kiwi fund investors: The easy way to steer safe in the $2.4 quadrillion tide
Article written by InvestNow – 30th November 2021
On any given day about US$6.6 trillion courses through global foreign exchange markets, according to the Bank for International Settlements (BIS), in a constant tidal movement of cross-border financial flows.
Estimates from the BIS, the central bank for central banks, put the entire value of tradable world currencies in 2019 at over US$2.4 quadrillion – or US$2,400 trillion.
The open-all-hours forex market dwarfs all others in scale, liquidity, and trading volume but its inner workings remain mysterious to most.
In its December 2019 Quarterly Review, the BIS says currency trading is “more opaque than many other financial markets because it is organised as an over-the-counter (OTC) market built upon credit relationships”.
And recently “changes in market structure, such as the internalisation of trades in dealers’ proprietary liquidity pools, further reduced the share of trading activity that is ‘visible’ to other market participants”, the BIS report says.
For good reason, forex trading is mostly the preserve of large global institutions that have the heft to manage the enormous financial risks at stake and navigate through the technicalities.
Retail investors can, and do, play the currency game through a range of derivatives brokers but the odds are stacked against them. For example, the recent CompareForexBrokers survey of 35 broking firms found on average over 70% of retail currency traders lose money.
“Although 29% of retail investors achieve capital gains, 99% of [forex] traders fail to make profits for more than four continuous quarters,” the report says.
But forex risk is much less problematic for long-term investors in managed funds. The majority of funds used in NZ for offshore assets already include several simple mechanisms to manage currency strategies.
Locals go global in risky world
Over 3.1 million New Zealanders now have at least some exposure to overseas-based assets through KiwiSaver schemes while many others – including the majority of InvestNow clients – invest into other global funds or even direct international shares through platforms.
Reserve Bank of NZ (RBNZ) figures show offshore assets accounted for more than half of the total $86.7 billion held in KiwiSaver schemes as at the end of this June – or about $44.8 billion including $32 billion in global shares. At the same date, over $19.5 billion of the total $51 billion retail unit trust market was invested in international equities, according to the RBNZ data.
Naturally, the 24-hour, seven-days-a-week action in global foreign exchange markets flows through to the value of NZ-owned offshore assets denominated in international currencies.
In brief: if the Kiwi falls, the value of overseas assets will rise in NZ dollar terms – and vice versa.
For long-term investors, the daily fluctuations in the relative value of the NZ dollar may be of marginal interest.
However, while persistent foreign exchange trends and interest rate regime changes can significantly influence returns on international assets for NZ investors, fund managers have a range of well-understood, flexible and easy-to-use currency management tools at their disposal.
Hedge options: all or nothing (or something in between)
NZ-based global fixed interest funds invariably hedge out currency risks for pragmatic reasons.
By removing the noisy effects of foreign exchange movements, any international fixed interest instrument will behave as investors expect of the asset class in general – providing capital stability and regular income.
Locally domiciled international share managers, by contrast, offer investors a much wider choice of strategies with more nuanced currency implications.
While some local fund managers who invest in offshore equities choose to actively manage forex risk (or even exploit it to juice returns), others expect any currency effects to wash out over time.
Anthony Edmonds, InvestNow founder, says investors should read fund disclosure documents to understand how managers (including KiwiSaver schemes) take account – or not – of currency risks.
“Currency hedging strategies can have a material impact on returns in any given period,” Edmonds says. “For example, almost identical global shares index funds may report wildly different returns – and if you didn’t understand their respective currency hedging policies, the results would be confusing.”
In addition to internally controlled currency strategies, some fund managers also leave the hedging choice up to individuals, or their advisers, by offering two versions of the same product.
For instance, InvestNow has long given members the choice of unhedged and fully hedged versions of Vanguard and AMP Capital global shares funds.
“And in October we also added a 100 per cent hedged option for the Harbour T. Rowe Price Global Equity Growth Fund to complement the unhedged strategy that has been on the platform for some time,” Edmonds says. “Investors can opt for either one, or mix the two to create a bespoke currency exposure.
“Overall, NZ investors have a great deal of choice and flexibility in how they manage foreign exchange risk. The solutions available here are easy to implement and administer through underlying managers that are well-experienced in forex markets and have access to good pricing and efficient execution.”
Eyes forward: rate changes ahoy, managers on watch
Historically, NZ managers have seen some performance uplift from currency hedging global shares as the so-called ‘carry trade’ favoured countries like New Zealand because of its high-interest rate regimes.
Under the typical forex hedging method, investors receive ‘forward points’ based on the interest rates of the currency in question.
NZ short term interest rates have generally tracked higher than other developed countries, but the spread has narrowed considerably in recent years – even falling below the all-important US at one point – in a trend compounded in the COVID-19 emergency era.
“With NZ interest rates not much different from the rest of the world, fund managers missed out on most of the forward points benefit,” Edmonds says.
Hedged global equities outperformed the unhedged equivalent in seven of the 10 calendar years from 2011 to 2020, data from Mercer NZ reveals, across margins ranging from 0.2% to 7.5%. In 2020, the Mercer analysis shows the hedged global equities index was up 11.2% compared to 8.6% for the unhedged variety.
Meanwhile, the RBNZ has moved ahead of global peers by cutting its quantitative easing (bond-buying) program and raising the official cash rate this year, which could have important implications for hedging decisions.
In a mid-November post in online publication Interest, regular contributor Roger Kerr, notes that local fund managers typically hedge between 50 to 100% of currency in offshore equities portfolios.
“Active currency hedging strategies have probably been on the back burner for many managers over recent years as equity market returns have been so spectacular, that the FX impact is very much on the margin,” Kerr says.
“However, should global share markets start to correct down on rising US interest rates in 2022, the fund managers will not want a rising NZ dollar value adding to their negative returns. The incentive to run higher hedge percentages is added to if the fund managers subscribe to the view that the US dollar will be on a weakening trend against all currencies next year.”
Forecasting forex movements, of course, is notoriously difficult. In a sea of US$2.4 quadrillion, anything can happen: InvestNow clients can keep watch knowing that the platform has the tools at hand to help them put their preferred hedging strategies into action on any given day.
Currency hedging for Kiwi fund investors: The easy way to steer safe in the $2.4 quadrillion tide
Article written by InvestNow – 30th November 2021
On any given day about US$6.6 trillion courses through global foreign exchange markets, according to the Bank for International Settlements (BIS), in a constant tidal movement of cross-border financial flows.
Estimates from the BIS, the central bank for central banks, put the entire value of tradable world currencies in 2019 at over US$2.4 quadrillion – or US$2,400 trillion.
The open-all-hours forex market dwarfs all others in scale, liquidity, and trading volume but its inner workings remain mysterious to most.
In its December 2019 Quarterly Review, the BIS says currency trading is “more opaque than many other financial markets because it is organised as an over-the-counter (OTC) market built upon credit relationships”.
And recently “changes in market structure, such as the internalisation of trades in dealers’ proprietary liquidity pools, further reduced the share of trading activity that is ‘visible’ to other market participants”, the BIS report says.
For good reason, forex trading is mostly the preserve of large global institutions that have the heft to manage the enormous financial risks at stake and navigate through the technicalities.
Retail investors can, and do, play the currency game through a range of derivatives brokers but the odds are stacked against them. For example, the recent CompareForexBrokers survey of 35 broking firms found on average over 70% of retail currency traders lose money.
“Although 29% of retail investors achieve capital gains, 99% of [forex] traders fail to make profits for more than four continuous quarters,” the report says.
But forex risk is much less problematic for long-term investors in managed funds. The majority of funds used in NZ for offshore assets already include several simple mechanisms to manage currency strategies.
Locals go global in risky world
Over 3.1 million New Zealanders now have at least some exposure to overseas-based assets through KiwiSaver schemes while many others – including the majority of InvestNow clients – invest into other global funds or even direct international shares through platforms.
Reserve Bank of NZ (RBNZ) figures show offshore assets accounted for more than half of the total $86.7 billion held in KiwiSaver schemes as at the end of this June – or about $44.8 billion including $32 billion in global shares. At the same date, over $19.5 billion of the total $51 billion retail unit trust market was invested in international equities, according to the RBNZ data.
Naturally, the 24-hour, seven-days-a-week action in global foreign exchange markets flows through to the value of NZ-owned offshore assets denominated in international currencies.
In brief: if the Kiwi falls, the value of overseas assets will rise in NZ dollar terms – and vice versa.
For long-term investors, the daily fluctuations in the relative value of the NZ dollar may be of marginal interest.
However, while persistent foreign exchange trends and interest rate regime changes can significantly influence returns on international assets for NZ investors, fund managers have a range of well-understood, flexible and easy-to-use currency management tools at their disposal.
Hedge options: all or nothing (or something in between)
NZ-based global fixed interest funds invariably hedge out currency risks for pragmatic reasons.
By removing the noisy effects of foreign exchange movements, any international fixed interest instrument will behave as investors expect of the asset class in general – providing capital stability and regular income.
Locally domiciled international share managers, by contrast, offer investors a much wider choice of strategies with more nuanced currency implications.
While some local fund managers who invest in offshore equities choose to actively manage forex risk (or even exploit it to juice returns), others expect any currency effects to wash out over time.
Anthony Edmonds, InvestNow founder, says investors should read fund disclosure documents to understand how managers (including KiwiSaver schemes) take account – or not – of currency risks.
“Currency hedging strategies can have a material impact on returns in any given period,” Edmonds says. “For example, almost identical global shares index funds may report wildly different returns – and if you didn’t understand their respective currency hedging policies, the results would be confusing.”
In addition to internally controlled currency strategies, some fund managers also leave the hedging choice up to individuals, or their advisers, by offering two versions of the same product.
For instance, InvestNow has long given members the choice of unhedged and fully hedged versions of Vanguard and AMP Capital global shares funds.
“And in October we also added a 100 per cent hedged option for the Harbour T. Rowe Price Global Equity Growth Fund to complement the unhedged strategy that has been on the platform for some time,” Edmonds says. “Investors can opt for either one, or mix the two to create a bespoke currency exposure.
“Overall, NZ investors have a great deal of choice and flexibility in how they manage foreign exchange risk. The solutions available here are easy to implement and administer through underlying managers that are well-experienced in forex markets and have access to good pricing and efficient execution.”
Eyes forward: rate changes ahoy, managers on watch
Historically, NZ managers have seen some performance uplift from currency hedging global shares as the so-called ‘carry trade’ favoured countries like New Zealand because of its high-interest rate regimes.
Under the typical forex hedging method, investors receive ‘forward points’ based on the interest rates of the currency in question.
NZ short term interest rates have generally tracked higher than other developed countries, but the spread has narrowed considerably in recent years – even falling below the all-important US at one point – in a trend compounded in the COVID-19 emergency era.
“With NZ interest rates not much different from the rest of the world, fund managers missed out on most of the forward points benefit,” Edmonds says.
Hedged global equities outperformed the unhedged equivalent in seven of the 10 calendar years from 2011 to 2020, data from Mercer NZ reveals, across margins ranging from 0.2% to 7.5%. In 2020, the Mercer analysis shows the hedged global equities index was up 11.2% compared to 8.6% for the unhedged variety.
Meanwhile, the RBNZ has moved ahead of global peers by cutting its quantitative easing (bond-buying) program and raising the official cash rate this year, which could have important implications for hedging decisions.
In a mid-November post in online publication Interest, regular contributor Roger Kerr, notes that local fund managers typically hedge between 50 to 100% of currency in offshore equities portfolios.
“Active currency hedging strategies have probably been on the back burner for many managers over recent years as equity market returns have been so spectacular, that the FX impact is very much on the margin,” Kerr says.
“However, should global share markets start to correct down on rising US interest rates in 2022, the fund managers will not want a rising NZ dollar value adding to their negative returns. The incentive to run higher hedge percentages is added to if the fund managers subscribe to the view that the US dollar will be on a weakening trend against all currencies next year.”
Forecasting forex movements, of course, is notoriously difficult. In a sea of US$2.4 quadrillion, anything can happen: InvestNow clients can keep watch knowing that the platform has the tools at hand to help them put their preferred hedging strategies into action on any given day.
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