Hedged ETF’s..good or bad?

By: ispeculatornew
Date posted: 11.04.2009 (5:00 am) | Write a Comment  (8 Comments)

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theworldNo matter where you live, you will probably want to consider investing abroad. Wherever you live, it is just one country and there have been numerous studies about diversification that proved its benefits. Some might argue the theory but in general, most agree that at least some diversification is useful. Living in Canada, I am in a country which includes not even 5% of the world’s stock market value. It would be foolish to buy only Canadian stocks in my opinion.

So here comes the big question. Suppose a Canadian would like to invest in the broad US equity market, what is the best way? Of course, I will suggest using ETF’s. But there are two main choices if investing in the S&P500, the main stock index in the US.

1-Buy an ETF such as IVV ($USD that tracks the S&P500)
2-Buy an ETF such as XSP (IVV hedged to CAD$)

There are of course many questions to be asked when asking you this question:

-Why are you getting this position?

If the reason is to get exposure to the US equity markets, then I would say that you generally are looking for a hedged return. That is, if the US markets goes up 10% but the US dollar loses 10%, would you expect to make about 0% or about 10%? Of course, the opposite may be true as well. It is important to know what kind of exposure you are looking for. Generally, I have been more interested in gaining exposure to the market than actually gaining both currency and market exposures, but both are possibilities.

-If you want a currency hedged position, which is best?

In this case, you have two options

#1-Buy XSP and become automatically currency hedged. This solution is a bit more expensive as there is an additional layer of fees involved (although usually it is rather small, in this case, .24%.

#2-Buy IVV and hedge currency exposure yourself: I think this can become attractive if you have a reasonable large position. Why? Because hedging currencies is not as straightforward as you might think. You would need to either trade Forex directly (more on that very soon) or trade a currency ETF (in this case FXC would be a good solution, it tracks the Cad dollar almost perfectly). But no matter how you hedge, your hedge will likely never be perfect. And depending on how often you trade, you will end up paying more or less than the actual hedging fees charged by XSP.

-So which should I do?

I think it’s defendable to do both, and that flexibility is one of the reasons why I like ETF’s so much. The point is that you must know what you are looking for. I think the US$ is currently very volatile and could easily head in either direction. Since the size of my position is currently very small, I doubt trading Forex for hedging purposes makes much sense. Because of that, I personally prefer going for the market right now, investing in XSP.

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  2. Comment by Zavi — November 4, 2009 @ 9:15 am

    I definitely take option #1. I’m a lazy investor and prefer to pay a bit more than having the trouble to calculate and hedge my currency position…

  3. Comment by John — November 4, 2009 @ 9:43 am

    If you want to profitably participate in international markets without having the additional frustration of having good index performance wiped-out by negative currency issues, you can with currency hedged ETF. I’m still stunned to see all those innovative products.

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