Forex hedging in your dividend portfolio

avatar By: IS
Date posted: 02.04.2011 (5:00 am) | Write a Comment  (0 Comments)

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If you are a Canadian investor, you are without any doubt running into this problem or question. “Should I be hedging my passive income portfolio?“. To think of it, almost every investor probably runs into this problem at some point. It’s true that most Americans mostly invest in US holdings but it has been proven again and again that international diversification has a very positive impact to any portfolio; adding additional return (expected return) for a diminished level of risk.

For all of the American investors, we will help you look for some foreign dividend stocks in Canada and Europe that could help your portfolio and for all other investors, you probably already trade on US markets given its size and importance.

-Should you hedge?

That is the million dollar question and I prefer warning you in advance: There is no easy answer to this question as even huge multinationals and governments struggle with the same question on a daily basis. Let’s take a look at the pros and cons:

-Pro’s; You have less volatility and are less exposed to large currency variations.

-Con’s: Currency movements are part of the additional return generated by international assets. Also, hedging strategies can become expensive and often lack precision or efficiency.

I personally think that investors should in most cases remain unhedged but there are specific cases where that would not be true. For example, an investor that lives off of passive income could be very affected if the exchange rates move too much.

-What should I hedge?

The big question is what should you hedge. I think that in the case described earlier, hedging the flows or even the entire amount could make sense but it all depends on how much variability you can live with both in the value of your portfolio and the flows. Both could easily move by + or -20% and if you could not sleep well at night with that uncertainty, take a hedge. The main thing that I would say however is that you should not try to do a perfect hedge, you will lose too much time, money and energy in the process.

-How can I execute the hedge?

There are many different ways to get it done of course, here are a few:

-Buying international dividend ETF’s (these will often already include some type of hedge)
-Forex: It can be risky if you try to make a living off of it but is often the cheapest way to hedge, trading forex is easy to setup too and very easy to understand.
-Forex ETF’s: We have discussed currency ETF’s in the past and while it is not always the most straight forward way, it can be fairly cheap and efficient.

What are your thoughts on fx hedging your dividend portfolio? Do you do it? Do you intend to?

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