I think the problem there is knowing quite how much to rebalance. We don't really know what the foreign exchange exposure of our equity investments is.I see what you mean.
My reasoning was that If you are a US investor you will rebalance from US bonds to US stocks in a crisis.
Most of my stocks are in the US market because I am globally diversified. So for rebalancing it seemed appropriate to have exposure to usd denominated bonds, to sell when buying a globally diversified stock ETF.
So for the US investor we can say that their liabilities are in USD, therefore the safe asset in their portfolio, high credit quality bonds, should be in that currency. By assumption, the US Treasury bond has 0 default risk. Unfortunately I can see political developments (which we can't talk about here) that cast slight doubt on that assumption. But there's not much we can do about that and if it happens, the disruption would be global (although the US would contrive to print money to meet any shortfall, I am sure).
A separate point is the US is 60-70% of world markets, so therefore should their US equity exposure (in their equity portfolio) be 60-70%.** But we don't know how much foreign currency exposure is embedded in that US equity portfolio (and conversely, companies in the UK say are highly USD exposed).
Your liabilities are in Euros. So the intuition is that the stable asset in your portfolio should also be in Euros. What you use to pay the rent, insurance, food etc. Whereas European markets are say 20% of the world equity index, so you absolutely want global diversification. How much currency exposure you take on the equity side is an interesting question, but the simplistic view, frequently held here, is that one should basically assume that currency valuations will eventually reflect differing inflation rates, so it will all work out in the long run.
(That's almost certainly not true, btw, but until you get within 10 years of retirement, it's not something to worry about. And by that time, you will own more bonds, probably have home equity (denominated in EUR), almost certainly have a state pension (ditto). So unhedged equity exposure is reduced anyways).
Another way of putting this might be that theory says you should be 100% hedged into Euros. Both fixed interest and equities. Because foreign exchange risk is not likely to be something that the market will pay you to take on. But most of us don't bother with hedging equities - content to ride the waves of currency volatility. Bonds on the other hand, unhedged, become just a currency play.
(As I have said elsewhere, a greater worry is the concentration of Eurozone government bonds in the weaker issuers eg Italy. Although it's the ultimate nightmare of an Italian Grexit style scenario, it's not something we can completely ignore. Thus the suggestion to hold a global bond fund, Euro hedged).
I've not come across good empirical data about the cost of foreign exchange hedging in funds. It *should* be low, but I just haven't seen that data.
** it's one of the longest running debates on these boards, and totally pointless to retread the thousands of posts long too and fro about it, whether US investors hold non-US stocks. Suffice it to say, for a non-US investor, a home country bias is absolutely the wrong thing due to the loss of diversification. Perhaps an exception in Australia (because of dividend franking, ie a tax credit you get for the double taxation of corporate profits (once in the corporate entity, again when paid out to investors). Vanguard empirical work for British, Canadian and Australian investors seemed to suggest a home country weighting of 20-30% at most was appropriate. US investors? Well if they miss 30% of world markets, by concentrating on their home market only, it's not going to have a huge impact on final returns, in the very long run.
Statistics: Posted by Valuethinker — Thu Jun 27, 2024 4:34 am — Replies 11 — Views 1650