Seeking Advice on Hedging FX Rate Risk when Holding USD Equities

23rd Feb '21 by RajPaulD

6 comments 323 reads

Hi All,

Just reaching out to the Stockopedia community for advice on the best way to hedge fx rate risk exposure to my US equity holdings.

I've been steadily buying into the US equities over the last 12 months, but my paper gains are being steadily eroded by the recent strengthening pound.

For example, I bough Berkshire Hathaway in July 2020, and to date its up about 30+ per cent in USD terms , but when my sale proceeds are converted back to GBP, my return is only about 19%. In effect an approx 10% increase in the GB:USD FX rate has eroded almost 40% of my profits!

Note, these are held in my SIPP and ISA with Hargreaves, so I don't have the option to sell and keep my gains in USD (selling forces conversion back to GBP).

Any advice on the best way to hedge my fx rate exposure would be rally appreciated.

thanks in advance

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sam19

23rd Feb '21

You could go LONG GBP/USD with a spread bet each time you take a position in a stock? Personally, I don't hedge and just put it down as a cost of doing business. Terry Smith sums it up pretty well in the quote below...

Our policy is not to hedge our currency exposure. There are several reasons for this. One is that we do not purport to be any good at currency trading. It has a cost which is often rather more than it appears when you are being sold the hedge. In addition, you cannot know what any individual company’s currency exposure is without knowing what hedging, if any, it has conducted in its own treasury operations. Experience would suggest that not
even the treasurer is sure of that on occasions. In any event, you cannot permanently hedge a portfolio or a company against movements in any commodity with a price which fluctuates. Many of the companies we invest in generate revenues in the
same currencies as they incur most of their costs. Therefore, their exposure to currency fluctuations is largely a matter of translation of their profits.
It is also a fact that if a fund is denominated in a soft currency,
its performance will look better than it will if it is in a hard currency. Again, we don’t intend to do anything to mask or alter that by hedging, as we don’t think it has any bearing on the real performance the fund delivers and we don’t know which currencies will depreciate and which will appreciate. However, if you think you do, you can always hedge your position.

Rusty2

I don't hedge my US holdings, I consider by buying US shares I'm already hedging as opposed to having all my shares in £s. I feel hedging now will be not worth it, the £ is likely to see a pullback, there will be many issues here to sort out this year when lockdown is over.

But it is something to take into account when buying and selling. I sold some last year which were down around 10% but because of forex rate, I actually made a profit. For me it's swings and roundabouts.
You could invest in this: https://www.hl.co.uk/shares/shares-search-results/w/wisdomtree-long-gbp-short-usd
But it would mean tying a lot of money to hedge and if the £ did fall you would lose that gain.

I'm in the process of moving my ISA to IG from HL, their transaction costs are so much lower than HL, I'm only paying 0.5% forex, no transaction fees on US shares, HL is £11.95 + 1% forex.

DamianB

24th Feb '21

A CFD/SpreadBet product will allow you to match size of your individual investments. Unless you are so big that each investment is many multiples of GBP62k, in which case use GBPUSD futures on the CME. They don't have carry costs like CFDs do, but they do have expiry rollover costs.

It can be worth doing. It is absolutely doable, and it really does not have to be complicated. Who cares about the companies internals. You are simply hedging the GBP value of your USDs. You are selling GBP to get USD, and whether you buy USD shares or hold USD cash or USD bonds or USD goats doesn't initially matter.

As Sam19 said: you really want to be initiating the hedge at the time you initiate the underlying investment. And you want to do so in the amount of GBP that you outlaid (sold) to buy the USD shares. In doing the hedge at the time of initiating the USD share investment, you instantly neutralise the FX risk component of buying a parcel of USD stocks. If you delay in initiating the hedge (your current situation), then when you eventually do initiate the hedge, you have also instantly become an FX speculator. And your risk is the gap between: (a) GBPUSD price at the time you bought the USD shares, and (b) the price of GBPUSD at the time of the delayed hedge initiation. In your current dilemma, that would mean GBPUSD falling the from the time you place the hedge (long GBPUSD hedge position). If you placed that hedge at the same time as buying those USD shares, then it wouldn't matter if GBPUSD went up or down from that moment, because your hedge (long GBPUSD) is an equal and opposite offset of your physical FX exposure (short GBPUSD) initiated at nearly the same price (for practical purposes, assuming your share broker isn't charging you a terrible FX rate when you buy USD shares with GBPO cash)

Some realities to consider:

- your hedge broker is eventually going to margin call you, or, close your position, if the hedge is losing money. For you, it is ok to lose money on the hedge, because you are making money on the physical FX position (sold GBP/bot USD). But the broker of your hedge doesn't care. And he isn't going to take your USD shares as margin against your hedge either.

- if you really care, one cost of the hedge is the lost interest earnings for the duration of the hedge on the margin cash that you used to run the hedge. So ideally, you want to hedge with a product/broker that offers the largest leverage possible. This will reduce the amount of cash you need to hold at the broker (margin) and hence reduce lost interest income. Hedging is cheap these days because interest rates are so low.

There may be carry costs with the hedge that the broker will pass onto you, or pay you. Oanda are pretty transparent, unlike others, and have their financing costs on their web page: As of Feb24 the financing rate is -1.13% pa for long GBPUSD positions, but that rate changes every day with underlaying interest rates and the FX Swap rate. So best you can say is that they will charge you -1.13% / 365 days for a long GBPUSD position held overnight today. And so on to recalculate tomorrow for one more day of financing. Financing is calculated on a daily basis and applied to your account each night. The rates don't change much unless the interest rate differential changes a lot. BIG HINT: When looking up financing rates, don't look at Wednesday's rate as it will be 3 times the normal daily rate, because it is the rate for 3 days of carry (Friday, Saturday and Sunday). Welcome to the world of spot/next FX swaps. Don't get too hung up on that. But when researching what you financing costs might be, just be mindful if you are looking at at a rate for a single day, or for a weekend. Keep in mind public holidays as well. FINAL BIG HINT: if a financing cost is expressed at negative percentage rate... do you pay the broker, or does the broker pay you? I'll leave that for your own research ;) Take a look at the long and short financing rates for EURTRY and think about what it means.
https://www.oanda.com/uk-en/tr...

RajPaulD

25th Feb '21

Hi DamianB,

Thank you very much for the detailed description of what I should be doing. The finer points you raise are certainly things Im gonna have to learn about - especially the carry costs and financing rates, and your exam question :)

Yes, its a shame I did not initiate the hedge at the time of each transaction - that would have been sensible(!). I don't want to be a ccy speculator - Im really not knowledgeable enough - rather I just want to hedge against GBP continuing to rise against the USD from today onwards. Every day it rises, I fee like I'm losing some of my profit.

A quick question : should I be looking to buy an GBP:USD option or simply take a spread bet in the GBP v's USD. And I really need to learn how to calculate how much margin I have to post if the position goes against me (I have never done fx trading, or options trading, so I really haven't much of a clue what financial product I should be buying).

And, each position isn't bigger than 62K, although my aggregate holdings in USD terms is more than this.

thank you again for your time

Thank you Herbie,

I could as you suggest wait (or hope) for the GBP to pullback against USD, but I don't feel that's for me: I don't know when that might happen. (Although I take your point that holding USD hedges against GBP exposure).

Thanks for the pointer to the Wisdom Tree product. I'll take a look.

I have my most recent ISA and my non-ISA trading account with Trading212 as they don't have transaction fees or fx fees (side note: it takes hours for them to fill an AIM listed share purchase ). I keep meaning to move move my old HL ISA over to them as well, but haven't got round to it.

The HL fees are onerous I agree (although I trade often enough to pay £5.95 per trade). Trading212 don't hold SIPPs or (LifeTimes ISA). I don't know if IG Index do.

many thanks again

Hi sam19, thanks for the reply and the pointer to what I should buy in order to hedge.

I don't quite agree with Terry, as my situation is different to his.

many thanks

Seeking Advice on Hedging FX Rate Risk when Holding USD Equities

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