(Source: Momentum Global Investment Management)
21 June 2020
What this chart shows
Above the chart shows the annual calendar year, total returns of the global investment grade bond market (including government and corporate bonds), with the red bars showing unhedged returns (in sterling terms) and the blue bars showing the returns of a sterling hedged investor. The unhedged returns reflect performance of both the underlying bond market and the overseas currency performance relative to sterling, whilst the hedged variant reflects purely the performance of the bond market with the investor shielded from exchange rate movements.
It is evident that currency moves can lead to a big difference in returns for the hedged vs unhedged investor, despite the underlying assets being the same. A prime example of this was in 2008 when the unhedged index delivered a large positive return due to sterling’s weakness against the underlying currency exposures of the global bond market (principally the US dollar, euro and yen).
In this case dollar, euro and yen strength significantly boosted performance. Another example was in 2016 when the vote for the UK to leave the European Union resulted in sterling weakness which again boosted the returns of the unhedged index. These are two examples where it has paid to remain unhedged.
On the other hand, when the overseas currencies weaken relative to sterling, the unhedged investor will lose money on the currency and underperform the hedged investor, who again is shielded from such movements.
Why this chart is relevant
The important point to take from this chart is simply the impact that currency movements can have on investments, particularly in fixed income where they can dominate the returns of an underlying asset class which has historically been used for more predictable, defensive return streams. The chart serves as a reminder that when hedging overseas currency exposure back into one’s home currency, you miss out when the overseas currency appreciates but you are protected when it weakens.
In comparison, an unhedged investment is at the mercy of exchange rate movements leaving the investor open to both positive and negative moves. Some follow the belief that currency moves balance out over time implying that over the long term it need not matter whether the currency.
The unhedged returns reflect the performance of both the underlying bond market and the overseas currency performance relative to sterling, whilst the hedged variant reflects purely the performance of the bond market with the investor shielded from exchange rate movements. It is evident that currency moves can lead to a big difference in returns for the hedged vs unhedged investor, despite the underlying assets being the same.
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