Discuss Hedging .... for layman.

[focus1974]

I put in $650 k SGD in Australian equities in 2010-11.
The exchange rate then was $1.3 sgd to $1 aud.

Now I liquidated my australian portfolio and got out $1.25mil aud.
The exchange rate now is $1 sgd to $1aud.

So, I actually lost $375k sgd without hedging. More than half of my initial capital.

Donno should feel sad or happy...



So, anyone know of simple hedging method that is easily implemented by layman to hedge the currency risk? On hindsight, if aud was depreciating against sgd at even $1.2sgd to $1aud and I hedge, i might have gotten away with the decline ..

This is a double edge sword..
Of course, at the same time.. my USD portfolio have appreciated as well ..
My avg capital cost is around $1.25 sgd to $1 usd ...
It has now appreciated to $1.37 sgd to $1 usd..

Now..I am thinking of how to lock in the gain and still hold on to my US equity.

 

[K|muRa^84]

how did u accumulate so much capital at such an early age?

 

[mynickname]

Technically you could open a retail forex account and buy forwards till the cows come home.

 

[dork32]

one way to hedge is that you borrow in aud to build your portfolio.

eg you borrow 500k aud (instead of using 650k sgd). when you liquidate your portfolio, you will make a profit of 750k aud regardless what the exchange rate is. this will result in a 750k sgd profit.

since you did not borrow, currency went against you and your profit is just 600k.

hedging will result in cost. in this case, the cost of hedging is the interest that you pay for the loan.

 

[Mecisteus]

Just take FCY risks as part of the overall risks investing in FCY denominated assets.

It doesn't make sense to hedge in the long term. Imagine if the hedging cost is 3% pa, you will be paying a bomb after 10 years.

 

[focus1974]

one way to hedge is that you borrow in aud to build your portfolio.

eg you borrow 500k aud (instead of using 650k sgd). when you liquidate your portfolio, you will make a profit of 750k aud regardless what the exchange rate is. this will result in a 750k sgd profit.

since you did not borrow, currency went against you and your profit is just 600k.

hedging will result in cost. in this case, the cost of hedging is the interest that you pay for the loan.

Ur cost of hedging is going to be as much if you borrow long term.
Interest rate then was 3-4%.

 

[CookieMonsta88]

I put in $650 k SGD in Australian equities in 2010-11.
The exchange rate then was $1.3 sgd to $1 aud.

Now I liquidated my australian portfolio and got out $1.25mil aud.
The exchange rate now is $1 sgd to $1aud.

So, I actually lost $375k sgd without hedging. More than half of my initial capital.

Donno should feel sad or happy...



So, anyone know of simple hedging method that is easily implemented by layman to hedge the currency risk? On hindsight, if aud was depreciating against sgd at even $1.2sgd to $1aud and I hedge, i might have gotten away with the decline ..

This is a double edge sword..
Of course, at the same time.. my USD portfolio have appreciated as well ..
My avg capital cost is around $1.25 sgd to $1 usd ...
It has now appreciated to $1.37 sgd to $1 usd..

Now..I am thinking of how to lock in the gain and still hold on to my US equity.

Not as straight forward, as the hedging will require alot of rebalancing, otherwise you can lose on both sides.the mechanics of hedging is, say 1 month from now you will have 1mil aud income, and you want to hedge, keyword is will have, implying if you don't have you will have to make up for the shortfall implying an imperfect hedge. Unless you are like Apple and your retail business is earning you say 500k aud, and you want hedge it, then this will be a perfect hedge.

Otherwise if you want to hedge exchange rate risk, you can only do it imperfectly by spot/forwards, or you do with options but need to pay premium.

If you try to mark it to the start of your portfolio, it implies you have put on 1 extra speculative trade as your p&l from your portfolio can't be predicted when you started the portfolio.

If you need to lock in exchange rate, can always use options, but need determine if the premium is worth while or not, otherwise your hedging will not be simple, but still viable.

If not say your money management allows you only to lose 75% then you mark to the 75% then you hedge that amount.

 

[Shiny Things]

So, anyone know of simple hedging method that is easily implemented by layman to hedge the currency risk?

Generally I think hedging your equity-implied FX risk is a pretty bad idea. It tends to be expensive, and if the FX goes your way, then you're going to lose money on the hedge and hate yourself for hedging.

But if you're hellbent on it, then sure, there are ways. Let's use your USDSGD hedging as an example:

Now..I am thinking of how to lock in the gain and still hold on to my US equity.

Couple of options:
1) If your broker offers margin trading, just sell a bunch of USDSGD. You'll end up with a long USD equities position, hedged by a short USD (and long SGD) cash position; you've effectively sterilised your USDSGD FX risk.

Upsides: easy, super duper liquid. Downsides: it's expensive (you're paying interest costs on the short USD balance every single day), and if USDSGD rockets higher you're going to have losses on the FX position.

2) Sell some USDSGD FX futures (these are tradable on the SGX). Boom, there's your FX hedge. Upsides: easy, liquid, and lower interest costs than trading cash USDSGD. Downsides: you have to roll it every month, so you're going to run up transaction costs.

3) Buy some USDSGD FX put options. Upside: your maximum loss on the hedge is capped. Downsides: you have to pay to maintain the position (because options expire), so it's expensive; USDSGD FX options aren't widely available to retail (except through Saxo, which sucks for other reasons).

3a) Sell some USDSGD FX call options. Upside: you earn premium. Downside: selling options is NOT A HEDGE; your gains are capped but your losses are not capped; also if you do this I will laugh at you because this is dumb.

4) Switch your exposures from cash to single-stock futures or synthetic longs via options, and then bring your cash balances back to SGD. Upside: very low interest costs because you don't have to maintain a large USD short balance; downside: higher transaction costs because you have to roll your equity longs every few months.

My personal preference would be 3) because FX options are my jam, but the lack of easily accessible markets for SGD FX options means that 2's probably your best bet if you want an explicit hedge.

 

[dork32]

Ur cost of hedging is going to be as much if you borrow long term.
Interest rate then was 3-4%.

but you still have 650k sgd. this 650k will be earning interest as well.

this interest can help off set part of the loan interest.

 

[focus1974]

but you still have 650k sgd. this 650k will be earning interest as well.

this interest can help off set part of the loan interest.

which is the same as losing the money .. now not thru FX risk,.. now is thru' borrowing cost.

If it's short-term strategy of buy and hold 1 year and then liquidate portfolio next year.. Your cost is 3-4% which is great as forex can go down 10-20%.

But I was holding it long-term which has been a good 8-10yrs? So the cumulative borrowing cost would have been 15-25% which is more or less equal to the FX fluctuation risk.

That's why i was seeking ways to hedge the risk by buying a once-off bet.

 

[Toni90]

U put your own money in stock then no need to hedge. Maybe need to put in different markets.

 

[focus1974]

Generally I think hedging your equity-implied FX risk is a pretty bad idea. It tends to be expensive, and if the FX goes your way, then you're going to lose money on the hedge and hate yourself for hedging.

But if you're hellbent on it, then sure, there are ways. Let's use your USDSGD hedging as an example:

My personal preference would be 3) because FX options are my jam, but the lack of easily accessible markets for SGD FX options means that 2's probably your best bet if you want an explicit hedge.

Excellent writeup..
But I am a layman and I think it's beyond me to try to do FX options and know the fair pricing.

Anyway, I have liquidated my AUD portfolio and converted everything to SGD cash.

Now, I just have to pray USD don't fall below $1.20 before I liquidate my USD portfolio (if ever).

Maybe it's easier to just buy an Index Fund for US equities that is SGD-hedged class.

 

[dork32]

which is the same as losing the money .. now not thru FX risk,.. now is thru' borrowing cost.

If it's short-term strategy of buy and hold 1 year and then liquidate portfolio next year.. Your cost is 3-4% which is great as forex can go down 10-20%.

But I was holding it long-term which has been a good 8-10yrs? So the cumulative borrowing cost would have been 15-25% which is more or less equal to the FX fluctuation risk.

That's why i was seeking ways to hedge the risk by buying a once-off bet.

you dont get what i mean.

you have 650k

case 1:
you change your 650k to aud500k to buy your property

case 2:
you keep your 650k, invest at an return of 3-4%
you borrow 500k aud at an interest of 3-4%
in the end you do not incur any interest charges.

 

[Shiny Things]

That's why i was seeking ways to hedge the risk by buying a once-off bet.

Hedging is never free, especially long-dated hedging. Doesn't matter whether you're hedging FX risk, commodity price risk, equity risk, longevity risk, whatever; there's always a cost somewhere.

It might be an explicit cost, like paying an option premium or paying away forward points; it might be an implicit cost, like capping your upside on a stock in return for protecting your downside; or it might even come in the form of taking on extra hidden risk (TARFs, anyone?). Or it might just be your bank ripping you off by fiddling with the price. But trust me, as someone who was on the other side of FX hedgers for ten years: there is no such thing as a free hedge.

As a side note: the borrowing cost of an FX hedge is usually offset by the value you earn from lending out the currency that you're long. For example, just checking my Reuters screen right now: a 3-year USDSGD outright forward is only about a 2.5% discount to spot (if you can find someone who'll quote you a 3-year USDSGD forward in retail size). So you're not going to pay away 15-25% to hedge it; you're only giving away the difference in interest rates between the two currencies.

 

[sAVaGEmP5]

if u bought aussie stocks with aussie currency, Im expecting to always hedge at the very first SGD to AUD exch rate @ 1.30. So u then use another account, eg your FX, to hedge your 650k.

Your aim is to have ur aussie stocks portfolio carry u, and have no currency related losses, thats the meaning of hedge. Theres only a little one time cost, the only long term cost is the different rate interests.

 

[focus1974]

You have plan for your money in SGD like e.g. to buy something in SGD?
Else, if I am in your shoe I would not change back to SGD until AUD forex vs SGD is more preferable. This is my way of hedging (by not converting back to SGD unless at favorable time). Any other hedging instruments are all meant for short-term. I don't know of any long-term hedging instruments that are cheap. If you figured out somehow, let us know!

ya.. going to buy property.
not interested in shares ... very tiring and no control.
just buy property and earn rental..
over long term.. property value track inflation is already seizable gain liao..
if you include your rental, it will be 100% gain over your property value.. but at least 500% gain over your ROIC (assuming leverage).

If your capital is large, your share holdings will never perform as well since you will not have the guts to put all your money in one or two shares and hold it over a cycle.

 

[DukeCS33]

I put in $650 k SGD in Australian equities in 2010-11.
The exchange rate then was $1.3 sgd to $1 aud.

Now I liquidated my australian portfolio and got out $1.25mil aud.
The exchange rate now is $1 sgd to $1aud.

So, I actually lost $375k sgd without hedging. More than half of my initial capital.

Donno should feel sad or happy...



So, anyone know of simple hedging method that is easily implemented by layman to hedge the currency risk? On hindsight, if aud was depreciating against sgd at even $1.2sgd to $1aud and I hedge, i might have gotten away with the decline ..

This is a double edge sword..
Of course, at the same time.. my USD portfolio have appreciated as well ..
My avg capital cost is around $1.25 sgd to $1 usd ...
It has now appreciated to $1.37 sgd to $1 usd..

Now..I am thinking of how to lock in the gain and still hold on to my US equity.

Some of the hedging considerations have been covered by other forum participants save this one:

If you have not any strong views on FX direction, you can hedge half your principal so that the effect of fx movements would not be as great. These means, you lose half your gains on favourable fx moves while you reduce losses by half, all subject to hedging cost. Top up or reduce the amount hedged by the amount your underlying property gains or looses over time.
This 50% hedging ratio can be further tweaked based on the correlation of the currency vs property movement.

Same concept applies for stocks.

 

[DukeCS33]

You have plan for your money in SGD like e.g. to buy something in SGD?
Else, if I am in your shoe I would not change back to SGD until AUD forex vs SGD is more preferable. This is my way of hedging (by not converting back to SGD unless at favorable time). Any other hedging instruments are all meant for short-term. I don't know of any long-term hedging instruments that are cheap. If you figured out somehow, let us know!

hmmm... that is taking on a price risk and therefore one can expect a further pnl from FX especially if the underlying property has already been sold off. There are a few examples of Singapore based Reits incurring hugh FX losses because they failed to hedge the FX risk. Now, most tend to borrow in the currency of the property that they intend to buy, so that's a form of natural hedging. If one is earning AUD rentals, then the rentals go off to service the loan interest as well. Capital gains are hedged if there is a known exit timeline. That way, one minimises his exposure from FX. Of course, there is no right or wrong answer - it depends on one's investment objectives and there is never a superior all correct answer that allows you to pocket gains from fx while not incurring cost.

 

[finale1]

Think of it this way... if AUD hasn’t fallen so much from 1.3 to 1.0, you wouldn’t have made so much in Australian stocks.

Because AUD is cheap and getting cheaper, foreign investors changed into AUD and buy up Aussie equity.

I put in $650 k SGD in Australian equities in 2010-11.
The exchange rate then was $1.3 sgd to $1 aud.

Now I liquidated my australian portfolio and got out $1.25mil aud.
The exchange rate now is $1 sgd to $1aud.

So, I actually lost $375k sgd without hedging. More than half of my initial capital.

Donno should feel sad or happy...



So, anyone know of simple hedging method that is easily implemented by layman to hedge the currency risk? On hindsight, if aud was depreciating against sgd at even $1.2sgd to $1aud and I hedge, i might have gotten away with the decline ..

This is a double edge sword..
Of course, at the same time.. my USD portfolio have appreciated as well ..
My avg capital cost is around $1.25 sgd to $1 usd ...
It has now appreciated to $1.37 sgd to $1 usd..

Now..I am thinking of how to lock in the gain and still hold on to my US equity.