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Why haven't int'l mutual funds benefited from USD decline?
Old 03-31-2008, 11:46 AM   #1
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Why haven't int'l mutual funds benefited from USD decline?

Someone stated in another thread that most foreign equity mutual funds are not currency hedged. But if this is the case, why has the performance of those funds not been better over the last year for American investors? For example, Vanguard has a fund based on the "FTSE All-World Ex-US" Index. The etf symbol is VEU and compared to one year ago, the price is almost exactly the same (~$53). There was one small dividend. If I go to the UK version of the FT website and look up the actual index, it reports similar results for the same time period (started and ended at ~297). So the returns for both the index and the ETF based on it appear almost identical.

BUT, over that same time period, the foreign currencies that denominate the stocks in the index have greatly appreciated. Based on the geographic distribution given by vanguard, most of the holdings are in: Europe (Euro +15%), Japan (Yen +15%), UK (GBP +1%), Australia (AU +13%), Canada (CAD +12%), Switzerland (CHF +20%). So if you take a weighted average of all those, the foreign currency gains to the US investor should've been at least 10%, but instead we didn't get any at all.

Other than concluding that Vanguard is hedging the currency exposure of its international funds, how else can you explain this?
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Old 03-31-2008, 11:56 AM   #2
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Originally Posted by soupcxan View Post
Other than concluding that Vanguard is hedging the currency exposure of its international funds, how else can you explain this?
I have no idea wheter Vanguard hedges currency or not. Maybe it does in some funds, doesn't in others.

But for discussion, there is a fundamental reason why foreign funds may not reflect underlying currency strength.

It is because they are equity funds, not pure-play currency funds. I wrote about this on this board several years ago when people were mentioning needing to invest in foreign equity funds to play a falling USD.

Simply put, the performance of the underlying equity will often trump the currency changes.

So the equities might be going down for various reasons, or no reason at all. The falling dollar might put stress on either their sales into the US, or their profit margins here. There may be concern about credit conditions in the US impacting them, or inflationary pressures.

Hedged foreign equity funds might be expected to have performed even worse.

Ha
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Old 03-31-2008, 11:58 AM   #3
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I've noticed this too. My international funds have been slaughtered in this recent decline. So obviously the equities have been punished far more than the currency gains.

I guess look on the good side - they would have done even worse had they been hedged!

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Old 03-31-2008, 12:04 PM   #4
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Simply put, the performance of the underlying equity will often trump the currency changes.
Agreed, but I thought I could avoid that by looking at the raw performance of the index which should not have any currency effects in it. Then I could isolate the currency effects by comparing the raw performance of the index to the realized performance of a US investor in the equivalent ETF.
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Old 03-31-2008, 12:10 PM   #5
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Agreed, but I thought I could avoid that by looking at the raw performance of the index which should not have any currency effects in it. Then I could isolate the currency effects by comparing the raw performance of the index to the realized performance of a US investor in the equivalent ETF.
Ok, I didn't realize you had done that. I would also reason like you did. If it didn't work, there must be some sort of tracking error or other source of slippage.

If it a particular investment you are concerend with, you might try calling Vanguard and see if they can explain it.

Ha
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Old 03-31-2008, 12:56 PM   #6
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What haha said.

If you look at world indices, most of them have been beaten down worse than the US. Taking end of Oct '07 as the peak, they've declined, roughly:
Britain: 6700 -> 5700, 15%
Germany: 8000 -> 6500, 19%
France: 5850 -> 4700, 20%
Japan: 16700 -> 12500, 25%
Australia: 6800 -> 5400, 20%
Canada: 14600 -> 13200, 10%

So foreign equity losses have exceeded US's while foreing currencies gained, so the net result is roughly about the same level of decline as US indices.
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Old 03-31-2008, 03:29 PM   #7
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UK (GBP +1%)
This seems pretty simple to me - but maybe I'm missing the point. If the USD and GBP are basically on par w/ each other over the last year (within 1%), then doesn't it stand to reason that any performance in a GBP-denominated FTSE index fund would not have any difference in performance when denominated in USD (as is the vanguard fund)? It seems the gains due to currency fluctuations everywhere else in the world are already factored in to the FTSE index performance results. The Euro, yen, aussie $, CAD, CHF, etc. have all appreciated vs. the GBP in about the same magnitude as they have appreciated against the USD. But the indexes of each of these countries have gone down in the last year. So the net result is a wash in terms of USD or GBP.

My guess is that the virtually all the various international indexes have shown net losses over the last 1 year period (when denominated in their local currencies), however based on vanguard's total international index, they are showing a gain of ~5% YOY as of 2/29/2008 close of business. That result would probably be much more negative w/o the beneficial effects of a falling dollar. Compare the 5% YOY results of the total international index vs. the -4% results of the US total mkt index over the same period. Diversification and exposure to foreign currencies still paid off over this period.
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Old 03-31-2008, 08:52 PM   #8
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This seems pretty simple to me - but maybe I'm missing the point. If the USD and GBP are basically on par w/ each other over the last year (within 1%), then doesn't it stand to reason that any performance in a GBP-denominated FTSE index fund would not have any difference in performance when denominated in USD (as is the vanguard fund)?
I see your point, but my assumption was that the index is "unitless" (that is, expressed in relative terms rather than denominated in a particular currency). And there is a section in the FTSE guide to the index calculations that seems to imply that the index should be currency-neutral. So I'm still not sure how to explain it.

8.0 FTSE CURRENCY HEDGING ALGORITHMS
The FTSE currency hedging methodology allows exposure to the returns of the foreign assets in the index without being exposed to the volatility of the foreign exchange rates.
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Old 04-01-2008, 01:43 PM   #9
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Soup,

Reading vanguard's "strategy and policy" statement from their website, it looks like the FTSE int'l mutual fund is probably unhedged. They state that they own the stocks contained in the FTSE all world index. They further state that they may use derivatives for purposes including providing liquidity/full investment of cash and to enhance investment returns when derivatives are more favorably priced than the underlying securities. I would guess they would put a statement regarding hedging of currency risk in this section somewhere.

However, they also state that they seek to track the performance of the FTSE index.

Maybe check the full prospectus to see if they discuss to what extent they hedge their currency bets? Or call them and see what they have to say?
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Old 04-01-2008, 02:16 PM   #10
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I checked VG's prospectus and it says they "may" use all sorts of exotic currency instruments, but gives no indication of how much hedging they expect to do, or how much they have historically.
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Old 04-01-2008, 02:27 PM   #11
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We live in a global economy - companies in country A that sell a large amount of goods to residents of countries B, C, and D will be directly affected by those economies. The effect of our volatile markets appears to trump whatever currency fluctuations are happening.

Correlations between domestic and international developed country stocks have been rising - this should not come as a surprise. I wouldn't expect it to stay that way though.

Look up the returns of euro stocks over the past 5-10 years denominated in USD versus their own currency. What we perceived as great returns were not experienced by residents of those countries.
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Old 04-01-2008, 10:33 PM   #12
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What haha said.

If you look at world indices, most of them have been beaten down worse than the US. Taking end of Oct '07 as the peak, they've declined, roughly:
Britain: 6700 -> 5700, 15%
Germany: 8000 -> 6500, 19%
France: 5850 -> 4700, 20%
Japan: 16700 -> 12500, 25%
Australia: 6800 -> 5400, 20%
Canada: 14600 -> 13200, 10%

So foreign equity losses have exceeded US's while foreing currencies gained, so the net result is roughly about the same level of decline as US indices.
I think Fluffy explained it correctly. Foreign markets lossed has exceeded the average foreign currency gains vs the dollar. Last I looked VEU portfolio (it is my main international fund) it contained almost entirely foreign stocks and very little non-equity positions.


The troubling thing for me is for the last 5 years or so foreign stocks have benefited substainially from great performance and weaker dollar. Eventually the dollar will strength and if the red hot international market continues to retreat we could be in for a double dose of trouble.
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