Hedging returns investors 14.5% more
The value of hedging has become clear to investors recently, with hedged foreign stocks and bonds returning approximately 14.5% more over the year to July 2005 than their unhedged cousins, according to Russell Investment Group NZ Managing Director, Dr Edward Schuck.
Friday, August 12th 2005, 10:24AM
Schuck said while recent movements in the New Zealand dollar will have delighted some investors and frustrated others, clients of global investment firm Russell Investment Group who implemented a long term 100% currency hedge last year will be elated.“Russell began advising clients in August 2004 to adopt a strategic 100% hedged position because our research showed this was likely to give the best risk-reward trade-off over the long term,” he said.
Schuck said in spite of the long awaited drop in the New Zealand dollar against other currencies, particularly the US dollar, hedging had proved to be a wise choice for investors.
“Twelve months ago the Kiwi was already perceived to be high at 64 cents and a fall was expected by many investors. The dollar went on to rise to a high of 74 cents in March and has since fallen to 69 cents. This highlights the truly unpredictable nature of the dollar,” he said.
The aim of hedging is to remove the impact of currency movements on returns from overseas assets such as shares. An unhedged investor in US assets would have suffered a 7.2% loss as the Kiwi went from 64 to 69 cents. Hedged investors were shielded from this loss as well as receiving extra gains from the interest rate differential between the US and New Zealand.
“Hedging is equivalent to borrowing money offshore and investing it in New Zealand cash, meaning investors who hedge benefit from the difference between New Zealand interest rates and those in the rest of the world. Although economic theory says the benefit here should be washed out by compensating currency movements, this doesn’t happen with the New Zealand dollar because of something known as the exchange risk premium,” he said.
Schuck said Russell research demonstrated that the exchange risk premium for the New Zealand dollar against major foreign currencies is generally positive, and is likely to persist, meaning investors should profit from hedging over the long-term.
However, Schuck did warn investors not to risk making the same mistake twice by assuming that the New Zealand dollar will continue its fall.
“Many investors make the mistake of trying to predict the path the New Zealand dollar will take and invest accordingly. Our experience is that even the experts cannot do this consistently.”
“Russell’s advice to investors is to adopt a strategic position – in this case, fully hedged and stick with it for the long-term,” said Schuck.
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