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Portfolio Update – July 2020 – The value of currency hedging

Portfolio Update – July 2020 – The value of currency hedging

  • Worst month for the US Dollar in more than a decade: how it impacts European investors who do not hedged currency exposure and how to protect against currency risk
  • Monthly portfolio update: Fairly stable month: impacted by negative currency movements
  • Book tip: Principles for Navigating Big Debt Crises by Ray Dalio (link at the bottom of the post)
  • In case you missed it: I have ditched all intermediate-term bonds (post from 3 August 2020)

Hi again,

Hope you are having a good summer so far, even though I am guessing it is spent quite close to home this year. Unlike others here in the Nordics, I have worked through July, and will have my vacation from mid-August instead. Looking forward to get some time off to read about investing.

I am really pleased to see that there seems to be great interest out there for low-volatility investing and balanced asset portfolio allocations. I strongly believe that the past decade has made stock investing feel easy, but there are more risk in it that you might have thought. Over the long term, the economy, and thus the financial markets, experiences big shifts in the long-term cycle. Now, total debt levels to GDP are at extreme levels not seen since the Great Depression.

This ratio is enhanced by decreasing GDP world-wide due to lockdowns and increased debt to cope with the effects of the coronavirus. Are we nearing the end of the long term debt cycle and are nearing a great deleveraging that must ensue thereafter? According to Ray Dalio, we were nearing the end of the long-term debt cycle even a year before the Covid-19 outbreak hit the markets, as he describes in a video posted by Yahoo Finance from early 2019.

That is quite scary when you think of it, and if I was heavily invested in stocks, I would be terrified. Luckily, several assets in the All Seasons Portfolio and a balanced portfolio will protect against such downturn. You will find a link to Ray Dalio’s book Principles for Navigating Big Debt Crises (2018) at the end of this post. If you have not read this already – it is now more relevant than ever.

Even though it is interesting, that is not the main topic for the day. Instead, we will be discussing EUR Hedged investing.

Currency hedged investing as a European in July 2020

Have you noticed, that in July 2020, we as European investors have fallen victims to currency risk when investing in American assets? I know that some of you readers do not have this issue as you mainly invest in European or eurozone stocks and bonds.

Due to increased uncertainty in the United States following a new increase in many states outside New York, has posed a threat for new lockdowns. Therefore, in July 2020, this was the worst month for the US dollar in over a decade, according to Financial Times. Investors became increasingly anxious over the economic recovery after the renewed coronavirus threat.

At the same time, Europe sees a relative improvement in number of new Covid-19 cases and fatalities. But the worry for a second wave has not disappeared. In Europe, the economies are continuing to open up, and at least from my personal Swedish perspective, we are finally coming down to the same case levels as the rest of Europe, and more countries open up their borders for Swedes.

The different in development on the both sides of the Atlantic Ocean, has had an impact on the EUR/USD currency pair. When the USD has been going through a rough patch, the EUR has remained fairly strong. This means that the USD has lost about 4.4% against the EUR in only a month, which is visualized in Table 1 below.

Table 1: EUR/USD monthly graph

So how does this change in exchange rates impact European investors?

Perhaps that is not the most complicated question to answer, but in simple terms: the values of American investments denominated in USD will be worth less when their values are converted back to EUR, which is the currency your portfolio value is calculated in.

For example, American stocks saw a rather good month in July 2020, led by strong quarterly reports from the big tech companies. The S&P 500 index gained a decent 5.5% over the course of the month when measured in dollars.

However, if you look at the development of an non-hedged ETF tracking that index, the Vanguard S&P 500 UCITS ETF, the value instead declined by 0.7% in July. That is a difference of more than 6%! The story is similar for government bonds, which also posted a good month in dollars, but a poor return when converted back to euros.

This means that even though the American stocks that the European investor has invested in, saw a good month, we still lost money… Rather annoying, but this is easily fixed. Instead, you could invest in ETF that are currency hedged, so that you are only exposed to the development of the underlying American asset, but not taking any currency risk.

In Table 2 here below, you find a comparison between non-hedged and EUR hedged stocks and bonds ETFs (blue and red, and yellow and green respectively), as well as the USD/EUR exchange rate (orange). The Tables (2-4) are indexed as at 1 July.

Table 2: Stocks and bonds ETFs vs USD/EUR

To protect against such losses caused by the changes in FX rates and currency conversions, you can hedge your currency exposure. The easiest way to achieve this is by investing in an ETF that is EUR hedged. This means that the ETF invests in the underlying assets (for example the stocks in the S&P 500), but also buys forward contacts or options for the currency they want to hedge against.

Looking at Table 2, by having hedged your currency risk, you clearly would have averted the losses of the worst month for the US dollar for a decade. It is quite how the decrease in exchange rate (orange) drags down the performance of the stocks and bonds ETFs from the red and green lines to the blue and yellow lines.

By investing in non-hedged products, your assets barely moved, despite strong months of the underlying assets. This is what happened to me at least (and as I am a Swede, I lost even more, because the Swedish Krona gained more against the dollar than what the euro gained (6% vs. 4.4%). Ouch.

In Tables 3 and 4, we have broken out the components of Table 2, so that you can easily compare stocks and bonds by themselves.

Table 3: Stocks vs. USD/EUR
Table 4: Bonds vs. USD/EUR

From the charts above, you can see how the decrease in the value of the dollar dragged down the performance of the stocks and bonds. The red line show how an American would have experience the past month by investing in dollars, and how it would have looked for you as an European if you would have hedged your American investments. A EUR hedge made quite a difference this month, even though the difference rarely is this remarkable.

But is now the right time to change from a non-hedged ETF to a EUR hedged one? It is hard to say. When the US dollar recovers next time, you would not take part of that increase, and you would have lost out on the gain of the currency move, while also now having lost out on the movements in the underlying assets. By hedging your currency exposure, you will not take part of any movements in the exchange rates that would have been negative to you, but also not any that would have gained you money. But as we want to limit our risks, currency hedging is a good choice.

It is difficult to time it right when one should switch from regular ETFs to currency hedged ETFs. And perhaps it is not part of your strategy to take active bets on FX fluctuations. Then, it may be better to transition over a longer period, so that you gradually lock in the the EUR exchange rate, while still being able to recover part of the FX loss if the US dollar recovers.

But because uncertainty is extremely big on the financial markets, the same goes for the currency markets. At least I am not good enough to forecast how the EUR/USD and USD/SEK currency pairs will develop in the near future.

What am I going to do? From my perspective, the Swedish Krona (SEK) has been losing value against all major currencies (EUR, USD, GBP) for the for the past few years. Therefore, I have chosen not to hedge my currency exposure, and also hoping to make a profit if that trend would have continued. Even though I just said I cannot predict the movements in the long term, I have a conviction that the SEK will continue to decrease in value of a longer term.

However, if I would be correct in that the SEK will be losing value, I still could buy ETFs with a EUR hedge. That is because, I have a much greater connection with the eurozone, than the Americas. Thus I could ensure I have OK purchasing power when travelling in Europe, by tying my American investments to EUR instead of having all that exposure in USD.

The issue is, that there are not many ETFs to chose from. For example, the iShares $ Treasury Bond 20+yr EUR Hedged UCITS ETF is only available on London Stock Exchange, while I mainly trade on Xetra (it is not available on Borsa Italiana either), but there are similar ones out there that gives exposure to longer bonds. If you would have found a preferred alternative, please let me know. But to be honest, I haven’t really made an effort to find hedged ETFs because, up until July, the currency impact has not had a big impact on the portfolio. By experiencing such a dip in the dollar as we did in July, we learn that hedging may not be a completely bad idea and worth considering.

EUR Hedged ETFs tend to be slightly more expensive than non-hedged ones, but the difference is negligible. For the stocks ETF in our graphs above, the difference is minimal: 0.07% for the non-hedged Vanguard ETF against 0.20% for the EUR Hedged iShares ETF. Still low cost, as you see.

The point of an All Seasons Portfolio or a balanced portfolio is to decrease volatility and thus decrease risk. For this purpose, currency hedging makes much sense.

The currency risk has been brought up by many readers in the comment section (for example by Carlo in the May 2020 portfolio update or by Stefano to my post about investing in negative yielding government bonds), as this is a real issue for European investors. It can be mitigated by either only investing in European and eurozone assets, or by investing in foreign assets (such as from the United States) but in ETFs with a currency hedge. Even though I did not act on it, the shifts in currency values in July have shown that perhaps I should have listened more closely.

And if you are interested in a EUR Hedged American portfolio or a portfolio with European exposure, I have a couple of example on the ETF Portfolio Inspiration page where you can start you research.

Portfolio Update July 2020

Let us now turn our attention to my All Seasons Portfolio. As described in my recent post about my correction that I posted in the beginning of August, I have ditched my mid-term bonds and now only have long-term government bonds and inflation-linked bonds in the bonds part of my portfolio.

And while the underlying assets that I hold (American Treasury bonds, TIPS and stocks) saw a rather good month, my portfolio performed quite sideways due to the currency effect described above.

However, such losses in currency have been at least partially offset also by increases in both gold and commodities. Gold saw another strong month with gains of 5.5% in July, and is now trading at record levels above $1,900/oz.

Looking more closely at my portfolio, gold is still increasing as a share of the portfolio, up about 0.5 percentage points since my June 2020 update to 12.3% of my total allocations.

In addition to gold, I am currently a bit overweight in commodities, and very slightly in TIPS. This could prove useful if inflation was to spike, as I discussed in a recent Deep Dive post about inflation protection. Now that the EU countries have agreed on the sources of the support for coronavirus impacted countries (by bonds and grants), the United States continue to stimulate the economy, the inflation risk has not yet diminished. I am not sure if I am willing to bet on high inflation in the short term, so I will not actively increase these positions.

However, if the economic growth would continue to weaken, my positions in gold and TIPS will prove helpful (as these are assets that do well in seasons of lower than expected economic growth). So will by government bonds, but I am very underweight in those currently after their decrease in value over the past 3 months since late March.

In the next graph below, it will be very clear that I have say good bye to my intermediate-term bonds since last month, and divided those funds into TIPS and Treasury Bonds. Besides this move, most assets have moved quite sideways, except for gold at the top, which has gained more than 5% MoM.

Since the beginning of the year, I am thus still in slightly negative territory, despite the huge gain in the gold price (although it now represents only 12% of the portfolio). Happily, both commodities and stocks are beginning to rebound. Stocks and bonds were impacted by negative currency effect this past month – otherwise I would have seen much better development over July.

Lastly, here’s a view of the ETFs in my portfolio, and the performance of each during the last month, in table form. I have included the intermediate-term bonds in this table, and those amount are split between TIPS and long-term bonds. The changes in percentage for TIPS and long-term bonds are however adjusted for the “new money” and shows actual change in value for the underlying asset.

iShares Global Inflation Linked Govt Bond UCITS ETFTIPSIE00B3B8PX14€458.40€607.76-0.56%
Invesco US Treasury 3-7 Year UCITS ETFGovt Bond MidIE00BF2FNQ44€392.20€0.00N/A
iShares USD Treasury Bond 20+yr UCITS ETFGovt Bond LongIE00BSKRJZ44€1,090.00€1,325.94-1.10%
Invesco Bloomberg Commodity UCITS ETFCommoditiesIE00BD6FTQ80€316.36€320.761.39%
Xtrackers Physical Gold ETCGoldGB00B5840F36€463.04€488.915.59%
Vanguard FTSE All-World UCITS ETFEquityIE00B3RBWM25€1,225.76€1,222.88-0.23%

This is all I had in mind for now. Thank you once again for your attention. If you don’t subscribe to the newsletter, now is a good time to sign up, so that you always get a notification when I add a new post (no spamming, but only updates on new posts).

I have also set up a Patreon site, to cover hosting costs, which reach a couple hundred euros annually. If you find any content here at all useful and feel that you can treat me for the equivalent of a double-espresso, read more about what this means on the Support page here on the website.

See you again in about a month, and I hope to hear your thoughts on currency hedging in the comment section.

Until next time, and stay safe,

Book tip: Principles for Navigating Big Debt Crises by Ray Dalio

For the 10th anniversary of the 2008 financial crisis, one of the world’s most successful investors, Ray Dalio, shares his unique template for how debt crises work and principles for dealing with them well. This template allowed his firm, Bridgewater Associates, to anticipate events and navigate them well while others struggled badly.

As he explained in his #1 New York Times Bestseller, Principles: Life & Work, Dalio believes that most everything happens over and over again through time so that by studying their patterns one can understand the cause-effect relationships behind them and develop principles for dealing with them well. In this 3-part research series, he does that for big debt crises and shares his template in the hopes reducing the chances of big debt crises happening and helping them be better managed in the future.

The template comes in three parts provided in three books: 1) The Archetypal Big Debt Cycle (which explains the template), 2) 3 Detailed Cases (which examines in depth the 2008 financial crisis, the 1930’s Great Depression, and the 1920’s inflationary depression of Germany&;s Weimar Republic), and 3) Compendium of 48 Cases (which is a compendium of charts and brief descriptions of the worst debt crises of the last 100 years). Whether you’re an investor, a policy maker, or are simply interested, the unconventional perspective of one of the few people who navigated the crises successfully, Principles for Navigating Big Debt Crises will help you understand the economy and markets in revealing new ways.

In anticipation for Ray Dalio’s coming book, The Changing World Order coming out later in 2020, this book will give you good flavour of what might be ahead of us. If (or when) the deleveraging part of a big debt crisis hits, a new world order is very likely to follow when another nation (likely China) will challenge the United States for the role as the world’s leading economy.

For anyone interested in the All Seasons Portfolio and Risk Parity investing, this is a great read that I strongly recommend. Or check out other great books on the topic on the Book recommendation page.

Check it out today on Amazon (affiliate link):

Buy it on

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