Currency Hedging - This is real life

[Bryan Barnfellow]

I am looking for some counsel from those who have some knowledge or experience with currency hedging.

As a resident in Switzerland (now and I hope after retirement next year) whose investments are almost completely located in the US (brokerage, a few mutual funds, a pension/annuity), I earn income in USD but pay the bills in CHF (Swiss Francs). While the exhange rate has improved about 7% in the dollar's favor in the last few months as the dollar has strengthened, the long term trend has been a 40-year decline (from about 4 Francs to the dollar to .96 Francs today).

I have budgeted for the first year of retirement using .90 (so the .96 is a nice surprise). My plan for budgeting is to keep 6 months of living expenses on hand in CHF and spend them down, while collecting the next six months in USD in the US accounts. Then move the dollars to Switzerland. Rinse and repeat. Long term, I'd like to at least try to neutralize the exchange rate as a variable in my budget if possible/feasible. I know you can buy forward contracts on currency pairs; but since this is a real-life budget that hangs in the balance, I know better than to dabble in this fairly complex art/science.

Any thoughts, advice, counsel? Thanks in advance!

-BB

 

[kramer]

At least for the brokerage part of your wealth (e.g, everything but your pension), I would think you could move some of that to Switzerland and invest in government bonds? I see that the yields on Swiss government bonds are quite low, unfortunately.

There is also a Switzerland ETF available in the USA (0.51% expense ratio). This has the additional benefit (besides Swiss currency exposure) of exposing you to standard of living inflation (not a perfect correlation but somewhat correlated).

I am assuming that you are reluctant to move more investments to Switzerland because of complex PFIC tax rules for US citizens? For investing in Swiss government bonds, at least, I think all you have to worry about is FATCA, and you will have to do that no matter what you do (even if the filing might be more complex in the over $50K category).

What is Switzerland's import profile -- Switzerland probably imports a lot of goods from Euro countries and being a small country imports a high percentage of goods overall? So you probably also want enhanced Euro exposure (and global currency exposure in general).

Also, how much you hedge would depend on how much of your wealth is from a US $ pension. I am guessing that LONG TERM hedging of a pension, which is really what you want, is very expensive and probably impractical.

 

[FIREd]

I hedge against the USD in 2 ways: foreign assets and commodities.

To gain exposure to foreign assets, you could move assets to Switzerland or simply invest in Swiss/European assets via a US-based brokerage account. If you plan on moving back to the US at some point, the second option is probably best. Since the SNB has more or less tied the CHF to the Euro in the last few years in order to protect Swiss exports, you could invest for example in a broadly diversified fund focusing on European equities or bonds. Or you could go for a more Swiss-centric ETF option. You could also buy individual shares of Swiss multinationals like Novartis.

 

[NYEXPAT]

I am in the camp that the Euro/Dollar will reach parity in 2017 and I would continue doing what you are doing and review once a year. I would also buy a nice position in (RIG) transocean, if you do not already own it.
Here in Peru we have (until recently) watched the dolla decline from 3.6 to 2.5 over the past 11 years. Currently it has risen to 2.9. I have my money in Dollars and convert to PEN only as I need it. Another helpful trick is to use your CHF credit cards to pay all bills and get the monthly float (only works with a rising dolla). If you have the ability to get a ST mortgage in CHP you could buy RE with the idea that you pay it off in 5 years.

 

[aja8888]

I am in the camp that the Euro/Dollar will reach parity in 2017 and I would continue doing what you are doing and review once a year. I would also buy a nice position in (RIG) transocean, if you do not already own it.
Here in Peru we have (until recently) watched the dolla decline from 3.6 to 2.5 over the past 11 years. Currently it has risen to 2.9. I have my money in Dollars and convert to PEN only as I need it. Another helpful trick is to use your CHF credit cards to pay all bills and get the monthly float (only works with a rising dolla). If you have the ability to get a ST mortgage in CHP you could buy RE with the idea that you pay it off in 5 years.

Just curious, but what's the rationale for building a position in Rig? In the light of oil prices declining due to increased supply and the high cost of deep water drilling, I don't see any good reason to invest in offshore rig companies.

 

[Totoro]

As a resident in Switzerland (now and I hope after retirement next year) whose investments are almost completely located in the US (brokerage, a few mutual funds, a pension/annuity), I earn income in USD but pay the bills in CHF (Swiss Francs).
-BB

Broker accounts = stocks I presume? Just buy a broad index fund that includes international stocks (like vanguard VT). Mutual funds same thing. That way this part of your portfolio is very weakly tied to the specific risk of the USD/CHF ratio.

Bonds: sell the USD ones, buy in CHF. Regardless of the interest rate. You pay your bills in CHF so that's where your cash and bonds should be.

Pension: That's probably impossible to tie to the CHF, so you'll just have to run the risk there. You can normally ask to be paid directly to your swiss account and thus convert in CHF.

Long story short: If you stay in switzerland you have no reason to hold stuff in USD (bonds/cash), nor concentrate geographically on the US (stocks, real estate). Move your financial life where your expenses are.

 

[Totoro]

There is also a Switzerland ETF available in the USA (0.51% expense ratio). This has the additional benefit (besides Swiss currency exposure) of exposing you to standard of living inflation (not a perfect correlation but somewhat correlated).

I'd advise against this. The companies listed there are few and multinationals. So you'll get a big concentration on a few companies whose earnings are not tied to the CHF anyway.

Illustration: iShares MSCI Switzerland Capped ETF | EWL

Largest holdings: Nestle (17%), Novartis (15%), Roche (14%), UBS (5%).

That's 50% in only 4 companies. None of those depend significantly on the CHF for profitability.

Go for a broad index fund including international exposure, like vanguard VT or similar.

 

[kramer]

I'd advise against this. The companies listed there are few and multinationals. So you'll get a big concentration on a few companies whose earnings are not tied to the CHF anyway.

Illustration: iShares MSCI Switzerland Capped ETF | EWL

Largest holdings: Nestle (17%), Novartis (15%), Roche (14%), UBS (5%).

That's 50% in only 4 companies. None of those depend significantly on the CHF for profitability.

Go for a broad index fund including international exposure, like vanguard VT or similar.

Thanks. I think this goes to the point that Switzerland is a tiny economy (only 8 million people) and so someone must be thinking global currency/equity there and also look at Switzerland's trade profile to hedge standard of living and currency risk.

I live in the Philippines and have some currency risk but there are a different set of factors than the OP due to Philippines less developed status. I ended up putting about 4% of my net worth in the Philippines ETF, maintaining caution about the diversification issues as you mentioned. I do think the local ETF is worth some kind of investment, but small only.

 

[NYEXPAT]

Just curious, but what's the rationale for building a position in Rig? In the light of oil prices declining due to increased supply and the high cost of deep water drilling, I don't see any good reason to invest in offshore rig companies.

First, it is a Swiss company.
Second, It pays a +7% dividend
Third, Price is nearing the bottom of the current commodity deflation cycle and will increase along with oil prices in the not to distant future.

 

[aja8888]

First, it is a Swiss company.
Second, It pays a +7% dividend
Third, Price is nearing the bottom of the current commodity deflation cycle and will increase along with oil prices in the not to distant future.

Thanks!

At $30 it pays a 10% dividend. While I've owned Rig in the past (pre BP mess), I am still leery of falling oil prices negating expensive deep drilling contracts. I will keep a close eye on it and maybe slide into a position for the longer term.

 

[Totoro]

While Transocean may be a good investment, it is a poor currency hedge regarding the USD/CHF exchange rate. It's profits or revenues are not really tied to the CHF, but to oil (and thus the USD).

Buying a house in Switzerland might be a good option on the other hand, especially if you can get a USD mortgage on it.

 

[clifp]

I don't see much of an option besides using Swiss currency futures as hedging mechanism. They are actually intended to be used for precisely your purposes.

As the soundest currency in the world, I would expect to the CHF to continue to appreciate against other currency over the long term. The zero interest (0.45%) that Swiss bonds pay is actually worth more than 10 year treasuries. If you figured the ~3.5% annualized appreciation over the last 40 years.

As others have pointed Swiss firms are the perfect example of an International company. So my real advice is find somebody who works in the finance dept in Novartis or a UBS banker, and ask how they hedge their US dollar exposure and see if you can't do the same.

 

[Bryan Barnfellow]

Dear all,

Thanks so much for the replies. Sorry for my late response; but w*rk raised its nasty head and we had a round of jousting this week. Cannot wait for these last 282 days to be gone -- but who's counting?

There are some issues with moving investments to CH, including some rather large capital gains which would have to be recognized and the fact that there would be significant tax withholding by the companies in the portfolio. Also, as has been pointed out Swiss firms (Nestle, Novartis, etc.) sell relatively little of their products in CH itself, so exposure to currency exhange differentials would not be avoided. The only bright spot would be that these firms hedge better than I could do, so that I would get the effect of that.

One thought: redirect some of my US-based investments into a local business (like a hair cutting salon, for example) whose cash flow is completely in Swiss francs. But that brings on a whole new category of risk that I am not familiar (or perhaps comfortable) with.

The long term trend is definitely written on the wall -- it will only get worse for the dollar versus the Swiss franc I believe, so making sure that my major portfolio allocation of dividend growth shares is doing its job (by growing on average 4% in real terms) is critical.

The currency hedging via futures contracts might help smooth things out on an annual budgeting basis; but longer term, the boat is taking on water. One good thing is that inflation in CH is very very low and it is possible to live cheaply (relatively speaking) by paying attention to special sales and buying in bulk where possible.

My wife and I don't own real estate here (which has been a very lucrative investment for Swiss property owners over the last decade or so); it's just too expensive, so we rent (as do about 70% of Swiss citizens). Our rent (while on a par with Manhattan in terms of what you get for the money) has not changed since we moved here in 2009. I have neighbors in my apartment building whose rent has not changed in 15 years. The law here is that unless the owner makes significant improvements in your apartment or can show substantial inflationary pressures, then he cannot raise the rent. The Swiss economy is remarkably stable and inflationary pressures are tiny.

Your many responses have given me a lot to consider and I am very appreciative for the time you took to give your counsel and ideas. Thanks!!
This forum is without a doubt the best anywhere on the 'net.

-BB

 

[FIRE'd@51]

You might want to consider currency options. This would allow you for a fee (the option premium) to participate should the exchange rate move in your favor while protecting you from an adverse move. There are currency options on FXF, the Swiss franc ETF. Even better would probably be the cash-settled options (XDS) that trade on PHLX. Typically currency options are significantly cheaper than equity index options because of the lower volatility in exchange rates.