Tag Archives: investing

The Benefits Of Currency-Hedged International ETFs

By Max Chen and Tom Lydon Currency-hedged exchange traded funds have become a popular way to access international markets while hedging currency risks. While some may be concerned about the costs of implementing these currency hedges, the benefits have outweighed the costs, reports ETF Trends . For developed international market exposure, investors have turned to broad EAFE – developed Europe, Australasia and Far East – Index ETFs, like the iShares MSCI EAFE ETF (NYSEArca: EFA ) and Vanguard FTSE Developed Markets ETF (NYSEArca: VEA ) . However, when accessing overseas markets, investors will be exposed to currency risks – a strengthening U.S. dollar or weakening foreign currency diminishes international equity returns. Alternatively, investors may look at a number of currency-hedged international ETF options to capture foreign exposure while hedging currency risks, such as the Deutsche X-trackers MSCI EAFE Hedged Equity ETF (NYSEArca: DBEF ) , which utilize currency forward contracts to diminish the negative effects of weaker foreign currencies. Some may be concerned about the costs to implement the hedging strategy, especially as fund managers sell a foreign currency forward at a different rate to where the spot rate is. Investors typically bear a hedging cost when the interest rate is higher on a foreign currency than it is on the U.S. dollar, Deutsche Asset Management strategists Abby Woodman, Dodd Kittsley and Robert Bush said in a research note. On the other hand the opposite is also true. When U.S. rates are higher than foreign ones, hedging becomes a net benefit for U.S. investors as there is a “positive cost of carry.” “For many currencies today, including the euro, pound, yen and Swiss franc, one-month interest rates are lower than they are for the U.S. dollar, resulting in a hedging ‘benefit’ to U.S.-based investors removing their international foreign exchange (NYSE: FX ) exposures,” Deutsche strategists said. Looking at DBEF’s underlying MSCI EAFE currencies, we see that that five of the 12 developed market currencies show negative one-month deposit rates, including a -0.17% rate for the euro, which makes up 30.4% of the EAFE index, a -0.21% rate on the Japanese yen, which is 24.2% of the index, and -0.74% rate on the Swiss franc, which is 9.3% of the benchmark. More importantly, most foreign currency rates to the USD show a positive spread – the U.S. dollar rate is higher than the foreign rates, which provides a positive cost to carry, or a benefit, for hedged investors. Specifically, among the top four currency exposures, which make up 83% of the EAFE Index’s weighting, the EUR shows a +0.70% spread to USD, JPY shows a +0.74% spread to the USD, the GBP has a +0.03% spread to the USD and the CHF has a +1.27% spread to the USD. “Anytime the U.S. dollar rate is higher than the foreign rate (the ‘Spread to USD’ row is positive) then there will be a positive cost of carry,” the Deutsche strategists added. “Or, to put it another way, the investor gets paid to hedge.” Currently, investors with currency-hedged developed EAFE market exposure are receiving a positive cost of carry from each of the four biggest currencies in the international basket. Deutsche X-trackers MSCI EAFE Hedged Equity ETF Click to enlarge Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

3 Things I Think I Think – Financial Crisis Edition

Here are some things I think I am thinking about: Warren Buffett on the financial crisis, investing with a sound premise & silly Congressional ideas. 1 – What Caused the Financial Crisis according to Warren Buffett? The National Archives released documents related to the Financial Crisis late last week. Among them were some interviews with Warren Buffett on the crisis. I noticed that, aside from being nerdy white guys, the only thing I might have in common with Buffett is that we both believe the cause of the financial crisis was, well, just about everybody: I think the primary cause was an almost universal belief, among everybody ‑ and I don’t ascribe particular blame to any part of it – whether it’s Congress, media, regulators, homeowners, mortgage bankers, Wall Street ‑ everybody ‑ that houses prices would go up. ” I’ve described this several times over the last 7 years and every time I do it, I seem to catch a bunch of flak from people with a political bone to pick. And every time I see someone trying to place sole blame on “the government” or “Wall Street” or “house flippers” or whoever, I am reminded of how common fallacies of composition are in the financial world. We don’t see things in totality. We see what we want to see inside of the big picture so we can confirm what we already believe. This just leads to a lot of narrow-minded thinking that causes more arguments than objective analysis. 2 – Investing with a False Premise. One comment I disagreed with (at least partly) was Buffett quoting Ben Graham on investing with a false premise: ” You can get in a whole lot more trouble in investing with a sound premise than with a false premise .” I don’t know about that. If you’ve read my paper on the monetary system or portfolio construction , you’ve probably noticed that this is the primary thing I am trying to avoid when analyzing the economy – false premises. There are so many myths and misconceptions about money that you can get into a lot of trouble buying into these ideas. Whether it’s flawed concepts like the money multiplier, crowding out, being a permabull/bear, dividend investing for safe income, “beat the market” or whatever. Starting with a sound premise is an intelligent way to improve the odds that you’ll succeed going forward. Of course, you have to maintain some rationality within this context. Extremists get killed in the financial markets because they tend to go all in on what they believe. Believing that house prices never go down was obviously irrational (and I had that argument with a lot of people back in 2005/6), but the fact that asset prices usually go up is not an unsound premise from which to start because the economy usually expands and people tend to become more productive over time. So, in this example, being a rational optimist always beats being a perma pessimist AND a perma optimist. 3 – Let’s talk about that silly balanced budget idea. One myth that just never dies is this idea that the US government is going bankrupt and needs to tighten its belt so we avoid impending crisis. I’ve spent an inordinate amount of time debunking this myth over the last decade, but I wanted to congratulate a group of economists for fighting back against a truly stupid idea – a federal balanced budget amendment. Mark Thoma linked to this letter yesterday highlighting the dangers of a balanced budget amendment. I’ll just point out two facts: First, one of the most powerful economic policies we have in place is what’s called automatic stabilizers. This is the tendency for the budget deficit/surplus to expand and contract naturally to offset economic conditions. So, during a recession, government deficits rise because spending naturally increases due to things like unemployment benefits while tax receipts decline. This leads to more income to the private sector and a flow of net financial assets that helps offset the decline. And the exact opposite happens during booms thereby cushioning against the risk of booms. If we had a balanced budget amendment in place, the economy would likely be a lot more volatile because these stabilizers would be gone. Second, the federal government plays an important role in ensuring that our states don’t turn into Greece. As I’ve explained before , since the states have balanced budget amendments, they are constrained by a true solvency constraint. The states, like Greece, have real limits on how much debt they can issue. But since the US states run trade surpluses/deficits against one another with no foreign exchange rebalancing then the poor states are always exporting more dollars than they’re importing. They can borrow to offset this, but there’s a Congressionally mandated limit to this borrowing. So, where does the income come from that helps avoid inevitable insolvency and occasional financial crisis? You guessed it – it comes from the federal government who takes more from the rich states and redistributes it to the poor states. It sounds like socialism, but it’s actually saving capitalism from itself. And it works beautifully in the case of a single currency system by helping us avoid the debacle of a situation that is Europe….

Does Market Volatility Favor Active Management?

By Aye Soe Twice a year, S&P Dow Jones Indices releases the SPIVA U.S. Scorecard. The scorecard measures the performance of actively managed equity and fixed income funds across various categories. Since the initiation of the report in 2002, the results have consistently shown that managers across most categories overwhelmingly underperform on a relative basis against their corresponding benchmarks over a medium-to-long-term investment horizon. The Year-End 2015 SPIVA U.S. Scorecard reveals little surprise. The second half of 2015 was marked by significant market volatility, which was brought forth by plunging commodity prices, a strengthening U.S. dollar, growing global concerns over Chinese economic growth, and the subsequent devaluation of the Chinese renminbi. Market volatility, in theory, favors active investing, because managers can tactically move out of their positions at their discretion and park themselves in cash. Passive investing, on the other hand, has to remain fully invested in the market. Investors in actively managed strategies should therefore realize fewer losses during periods of heightened volatility, all else being equal. Given this theoretical background, recent volatility in the market has supporters of active investing proclaiming that active management is back in favor. However, over a decade of experience in publishing the SPIVA Scorecard has painfully taught us that active funds don’t always perform better than their passive counterparts during those precise periods in which active management skills seem to be called for. Exhibit 1 compares the performance of actively managed equity funds across the nine style boxes during the 2000-2002 bear market, the financial crisis of 2008, and 2015. As the data clearly show, there is no consistent pattern across most of the categories. Large-cap value managers appear to be the only exception to the losing trend, outperforming their benchmark in both bear markets. Again in 2015, mid-cap value is the only winning equity category, with the majority (67.65%) of them outperforming the S&P MidCap 400® Value . Disclosure: © S&P Dow Jones Indices LLC 2015. Indexology® is a trademark of S&P Dow Jones Indices LLC (SPDJI). S&P® is a trademark of Standard & Poor’s Financial Services LLC and Dow Jones® is a trademark of Dow Jones Trademark Holdings LLC, and those marks have been licensed to S&P DJI. This material is reproduced with the prior written consent of S&P DJI. For more information on S&P DJI and to see our full disclaimer, visit www.spdji.com/terms-of-use .