When you are investing you have two main concerns; you don’t want the stock, ETF or whatever financial instrument to decrease in value and secondly, you don’t want the currency that investment is priced in to devalue against your home currency.
In today’s blog post we will focus on that second concern, whether as an investor in Europe you should be hedging your foreign investments.
Of course, if you solely invest in companies based in the European Union then you will not likely have to worry about currency risk. But the vast majority of investors have at least some exposure to US stocks such as Apple, Google, Tesla, etc.
Fx Swings can have a big impact on investment returns
Although on a day-to-day basis you don’t really feel the ups and downs of forex changes, over a year they can have a massive impact on your investment returns.
Over the past 5 years, the EUR/USD currency pair has seen significant swings and has ranged between €1/$1.25 to now the euro at one of the lowest positions in its short history of €1/$0.99.
The current devaluation in the Euro due to the war and energy crisis thus far has benefited those who hold most of their investments in US companies. But the Euro could very well be close to if not already hit its bottom against the Dollar.
If we see a correction over the coming months where the Euro regains some of its strength against the Dollar then this would negatively impact your investments which have the Dollar as its base currency. If this were to be true then it could be financially beneficial to hedge against this potential loss.
What are your options for hedging your portfolio?
This may sound like a lazy strategy but depending on your time horizon, doing nothing could be the way to go.
The below graph shows the average annual change in the GBP/USD exchange rate over different time frames. The longer your time frame, the less of an effect currency fluctuations will affect the performance of your investment portfolio. Not everyone has the patience to invest over a 10-15 term but for those who do, you may not have to worry about currency risk ( outside of that caused by political turmoil).
Currency movements can have a large impact if you are investing for a short period of just 1-3 years and it may be worth considering putting together some strategy to offset any potential FX losses.
Currency Hedged ETFs
If your investment of choice is Exchange Traded Funds that track popular indexes such as the S&P 500, then there may well be currency hedged versions of the financial product available for you to trade.
A great resource available to European investors is the JustETF.com ETF screener, which allows you to screen by industry, provider, domicile and many other criterial including an ability to search for Euro, GBP and USD currency hedged ETFs.
Over the 12 months to August 2022, Distributing funds VUSA & VUAG that track the S&P 500 returned 6.97%/7.88% respectively, which are both denominated in GBP, whereas the equivalent funds VUSD & VUAA funds which are denominated in USD had a negative return of -8.18%/-7.03% respectively.
This was due to the strengthening of the dollar against the pound over the last 12 months. 1$ would get you £0.73 in August 2021 and now it will get you £0.85 in August 2022.
Spread out your investments over many different currencies
Another way to avoid having currency risk is to diversify your investments among a couple of different currencies to ensure you are not overly exposed to any one currency. Investors are often advised to diversify their portfolio so they their returns are not overly reliant on any one particular company but this could also be said for currency.
The downside of this approach is that outside of the US, UK and European markets, there are not many mature markets with large investable companies. Hence why most investors stick to US stocks primarily.
Hedge your whole investment with a small amount of capital using CFDs or Options
If you want to fully hedge a $10,000 investment in a US stock, then you need to borrow $10,000 and exchange it for the equivalent amount of Euro. This is completely impractical for the everyday investors but there is another way to go about it that requires you to put up far less capital.
Options and CFDs will allow you to trade with large amounts even with small amounts of capital due to the leverage they offer. But beware, options and CFDs are complex financial instruments that require a certain level of expertise to trade.
For example on Trading 212 you can trade the EUR/USD currency pair with leverage of 1:30. This means you just need to invest €333.33 to hedge a $10,000 investment.
The Downsides of Hedging
When you hedge your currency risk you are protecting yourself against any potential downside of your home currency appreciating in value against the currency you hold your investments in (in most cases US Dollar).
But on the flip side, when you hedge your currency risk you will be ruling out the chance of benefiting from any favourable currency movements. In most cases, this would mean the Euro depreciating in value against the Dollar for Europeans.
Disclaimer: This blog post is for informational and educational purposes only and should not be construed as financial advice.