Caution needed when hedging equities

Unlike bonds, which can be hedged 100 per cent back to the local currency for good returns with little risk, equities can produce very different results depending on portfolio time periods and fund management costs, according to Vanguard Investments Australia head of fixed interest Mathew McCrum.

For example, over 10 years, an unhedged equities portfolio produces a 5 per cent return for a risk of 13, while the same portfolio hedged produces a 6 per cent return for a slightly higher portfolio risk of 15.

“Currency movements are random and it is impossible for even the most astute investor to predict its future direction,” McCrum said.

“For this reason, many investors and advisers choose the strategy of least regret, which is to hedge 50 per cent of the portfolio and leave the remaining 50 per cent unhedged.”

In another approach to reducing risk, McCrum suggested investors select managers based on a strong currency management process and one that is focused on reducing overall costs, which can have a significant impact on the fund’s net return.

McCrum explained that with a $100 million fund, the manager with the highest transaction costs of 0.013 per cent per month would add $156,000 in costs over the year, compared to only $48,000 in costs for the low-cost manager transacting at 0.004 per cent per month.