Achilleas Taxildaris: Hedging in global equity funds is a more complicated exercise than a U.S.-only equity fund. And the simple reason is the fact that a global equity fund has exposure to many different currencies, starting with the U.S. dollar, sterling pound, the euro, Japanese yen, and then if it has exposure to emerging markets, then it has exposure to several smaller currencies and it's much harder to track how the Canadian dollar fares versus all of these currencies.
How does the Canadian dollar perform against other currencies?
Over the past year the Canadian dollar has underperformed significantly versus the U.S. dollar and the UK pound. It has done a bit better but still under-performing over one year versus the other major currencies. Over five years, the story is very similar, with the exception of the Japanese yen, but when we look further back, we can see that the Canadian dollar had a very strong decade from the early 2000s. And if we expand to the whole history and go as far back as ‘87, then we can see that the results are more muted and far smaller on a cumulative basis.
What does this mean for fund investors?
Obviously when the Canadian dollar does well, hedged strategies get the benefit. So in the decade from early 2000s, the hedged funds have outperformed their unhedged counterparts, and more recently, the non-hedged strategies have done better. But it's not just about performance. We've seen performance chasing does not lead to good results at the end. It's more important for investors to keep following their plans and see how the fund fits into the total portfolio. So when we look at correlations, we can see that hedged strategies tend to correlate higher with the Canadian equity market, whereas non-hedged strategies on a global or U.S. basis as well have lower correlation. So over the long-term they do add diversification benefits by leaving it unhedged.
How do managers adjust the currency exposures in a fund?
So generally there are three different options in terms of hedging in global equity funds. There is the product decision of being fully hedged or fully unhedged. That means that the manager won't practice any currency hedging themselves, and if the fund is fully hedged, it's done by a separate team and it's not based on investing criteria. It's just a product decision and that will allow investors to decide how it fits into their total portfolio.
The second option is when it’s actively managed by the managers. Some managers are bit more active and they're going to be more opportunistic on the short-term. Other managers are more long-term and they are generally going to take some positions in extremes. A good example is Japan: This year, several managers who do not often hedge took the opportunity to hedge their Japanese yen exposure.
The third option is somewhere in the middle. There are some guidelines for the fund and the currency exposure it can have and the managers will play around that guideline. For example, it could have a limit of 50% exposure to foreign currencies from 0 to 50%, and the neutral could be considered at 25% and the manager will decide to over-hedge or under-hedge over that 25% limit, for example.
How can investors find out about a fund’s currency exposure?
Finding out the currency exposures can be fairly easy, looking at the financial statements. However, it's much harder to understand what the policy is around currency hedging. So in the financial statements, there are all the risks listed and within is also the foreign currency exposure as a risk and usually it's listed the main currencies that the fund is exposed to and the percentages as well as the impact that may have.
But from that alone it's harder for the investor to figure it out what the currency management or the policy that the manager or the fund follows. For example, a fund that is fully hedged, you go in the financial statement and you see that the fund has zero exposure, it might allow the manager to have the opportunity to do currency hedging in the future. So just from the regulatory filing, it's harder to understand what the policy is. So it's always good for investors to either speak with their advisors and ask this question or contact the fund firms themselves and ask that question, and the answer should be one of the three options mentioned before.
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