 Good day, fellow investors. When it comes to international investing, you don't only have to worry about stock prices going up, but also about currency fluctuations. So you have double the volatility than when you invest in the domestic market. But when you invest globally, you have many more opportunities to invest, to find better businesses cheaper, margin of safety. So it's always smart to look globally when it comes to investing. Now, the question is, should you care about those currency fluctuations or focus only on businesses? How to hedge if you care about those fluctuations? What's the best way? And is it something that you should put your effort into? In this video, we'll explain currency hedging. We'll explain historical results, data, scientific correlations, everything to show you all the necessary information you need to see whether currency hedging and what kind of currency hedging is necessary for your international portfolio. If you don't have one international portfolio, you will also see, okay, whether you should invest abroad and what kind of risks and rewards it can bring to you. Let's start with first what is currency hedging, how it can be done, what is the historical benefit to those who have hedged or not hedged their currency exposures and we'll finish with a very interesting analysis of the strongest currency in the world, the Swiss franc and how Swiss investors should have been better also unhedged or they should have focused on something else not on currency. Let's start. So what is currency hedging? Now let's say you're an American investor, you want to invest in a European company, European stock. Now you buy the stock let's say for 100 euros, you exchange your dollars into euros, you buy the stock and then after a year the stock is at 200 euros. You would say great but in the case that the euro let's say loses 40% against the dollar that or one dollar was one euro, let's make things easy, one dollar one euro and then after a year one dollar is 1.66 euros then your gain isn't 100%, it's just 20% on what you invested and that is currency risks. There are plenty of risks in currencies especially these days with all the monetary printing so that one is really okay should I think about those investments, those risks or not and then you want to say okay how can you hedge about that where if you are a long European stock and US investors or a European investor or a US stock wherever you are from if you invest internationally you should then go short the currency. So if the currency you are holding the asset in devaluates then if you are short the currency for the amount you have invested abroad then the currency fluctuation does not impact your investment. So if you are short the euro the euro devaluates the short the value of the short increases in relation to the decline of the devaluation of the currency. So there are many ways that you can be short something let's discuss four of them and then see how those might fit you or not. So you can hedge yourself in various ways one is that you use an ETF to short the respective currency against your currency however you have to understand that this is ETFs and such schemes such derivatives are mostly for daily trading and actually structure to go to zero at some point if you read the prospectus for example plus there is an expense ratio of 0.95 costs of buying or not buying and especially you're also exposed to those daily compounding returns and spreads that might not really give you a perfect correlation to the asset. So in my opinion all these ETFs daily ETFs are just made and invented for those people that want to look smart when buying such derivatives such financial instruments but the real value for long-term investors is zero of these ETFs. Second you can use hedging contracts for difference so contracts for difference you agree to pay or get the difference in the currency pair over a specific period of time. Again complex structures actually bend in the United States but if you're not from the United States you might see for such contracts and then see what is the spread what is the cost etc. Then hedging currency risk with forward contracts a forward exchange contract a derivative again allows you to lock in an exchange rate now for a predetermined date in the future. These contracts can last for a month three months and maybe even longer so you have to roll them over constantly the exchange rate is calculated by discounting the interest rate differentials. Then block to a certain date in time. Similarly to contracts you can also use options where you buy them or sell them depending on what you need but if you buy an option on a currency you get the right but not the obligation to exchange currencies at a predetermined date and exchange rate. You can buy those and be hedged at fixed cost or you can sell options and then be exposed to whatever happens. So now that we have explained hedging you know how to hedge and it's really easy right? Of course not I think that the four instruments that I just discussed are a extremely complicated futile for 99 percent of the population 100 percent of the population those that use them just try to look smart and actually it's something you are not needing you will never need and it's not something that would add value to your returns. Let me give you academic research that shows that hedging is not important at all so we can make investing simple and actually that's what I do on this channel make investing simple if you use common sense if make things simple investing is easy look at the risk reward what am I buying what is the business and that's it. When you start complicating the fees there is one certainty the fees go up skyrocket you are more and more entangled and you don't see the woods from the tree let me show you the academic research. So Credit Suisse 2012 yearbook had a big part dedicated to currencies so from the London Business School of Economics Professors Morson Demes and Stoton discussed how currency doesn't matter because okay if you invest globally you reduce portfolio volatility but when it comes to hedging it's actually better to have unhedged cross-border stock exposure when currencies are weak so you invest in countries that have temporarily weak currencies and it's better to be unhedged then. Short-term currency hedging is found to be particularly meaningful in bond portfolios okay bond investors are suckers on this channel so we don't have to comment on that when it comes to equities it also contributes to risk reduction keep in mind risk is volatility measured over the short period for time but less risk reduction than when it comes to bonds and then the conclusion is very simple when it comes to long-term investing hedging benefits are found to fall off with longer investment horizons they have given us the number to show what hedging and no hedging means if we look a US-based investor from 1972 to 2011 if we look at the yellow no hedging returns the geometric and arithmetric mean returns those are whatever he would have invested in are higher than the hedged returns and the difference is that the standard deviation the last column so the volatility is the highest so all you need to survive is the volatility but if you are a long-term investor you don't care that much about volatility you care about maximizing investment returns then if you're an international investors on the other hand returns not hedged and hedged are pretty much in line a little bit lower for the non-hedge depending on what but equally so there isn't really a benefit of hedging when you include the cost the standard deviation is always higher the third column but the benefits aren't there and that's their conclusion also that there are no benefits when it comes to currency hedging for long-term portfolios can fisher from fishery investments and mere statement they have also looked at hedging and they have found that investors over a 15-year period analyzing hedged and non-hedged US international portfolios they found that returns are equal to those of that returns to hedged portfolios are equal to those of unhedged portfolios the only issue here is that behavioral investors when there is more volatility focus on dot volatility and hedge increasing their cost and then regret based on hindsight oh i should have hedged now i'm not hedging not no need at back and forth and so they actually do a disservice to them so if you're an investor over the long term sometimes you win sometimes you lose on currencies that standard deviation the volatility is much higher but over the long term your actual returns are not lower because you are unhedged so when it comes to investing it's not necessary to being hedged not even if you are a swiss investor with the very very strong frank and strengthening frank over the last 10 years it might look that you are hit you're losing money but other things matter much much more when it comes to investing one of those things that matter more is currency diversification currency is always ebb and flow in relation to inflation expected inflation or interest rates in the country the US dollar index shows how the dollars is sometimes strong sometimes weaker but the index over what 50 years here 25 yeah 45 50 years hasn't changed that much is what's 100 at the start in 73 46 years later it's 92 so it didn't really change that much because currencies move alongside inflation uh in the country prices when it comes to investing on if you buy equities if you buy assets adjust for that inflation so it's not really that you can lose much if you worry about currencies just a quick example a stock that we discussed here often on the channel Gatsprom was just upgraded yesterday by Morgan Stanley now that the stock is up more than 100% now they upgrade it but Gatsprom we know it's a Russian company so it's different currency traded in a different currency and okay what's my risk if i buy Gatsprom if the rubble loses value then people might say okay you lose value but then think again what's Gatsprom doing is selling gas in Russia is selling gas in China is in Europe usually in US dollars so it is exposed to both dollars to both rubbles it's diversified most companies in the world are globally diversified so they have some benefits here some benefits there and as always those ebb and flow and the overall long-term return doesn't relate at all to currencies it relates to the strength of the business depending on global gas demand no matter what the currency that will also be the return for Gatsprom and similar companies so always focus on the business not on the currency in the long term we see here how exchange rate and inflation for 83 countries between 1970 and 2011 are pretty correlated so if there is inflation currencies will weaken if not they will not but you if you buy businesses if you buy good businesses not at exuberant valuations then you are protected from inflation and thus also from currencies so it always boils down to the same buy businesses be a value investor buy with a margin of safety buy quality assets buy great businesses that have price in power in case of inflation and then you don't have to care about currencies you don't have to pay about pay those extremely high hedging costs stress just leave volatility to volatility take advantage advantage of it because volatility makes things very very cheap here and there buy that enjoy the process and be a value investor not a currency trader enjoy life don't stress on things that you can't control and then over the long term don't really matter let's see the case example on the swiss market so just for fun let's discuss the swiss investor they are all very concerned about currencies the swiss frank appreciated against all currencies over the last years especially from 2001 to 2011 however since 1991 it appreciated just 20 percent against the dollar 20 percent over almost 40 years is a difference of just a bit more than 0.5 percent in yearly returns keep in mind 0.5 percent and even the 2001 2011 difference of 45 percent in change in currency value is still just a bit above 2 percent on a yearly basis now when it comes to that should the swiss investor stick to domestic investments or diversify globally the 2 percent rate of returns on a yearly basis that's the difference between a price earnings ratio of what 10 and 8 so just a small p-e ratio on the earnings yield the swiss cyclically adjusted price earnings ratio for the market is 26 and practically 26 is what the 4 percent return so you need a 6 percent return to offset even a 2 percent yearly difference in returns between the frank and other currencies so germany is there germany is what 17 and other european countries have lower k-pratials so that would be enough to offset any kind of divergence between currencies over the very long term not to mention that currencies also ebb and flow so no matter where you are no matter how strong your currency is or not if you focus on businesses even if your currency strengthens 100 percent and you are invested globally that 100 percent over 10 20 years is less of an importance than what is the business that you have bought if you buy a great business no matter where let's say you lose 50 percent on currency because your currency strength at 100 percent but if you buy a good business and you make five times your money over 10 20 years then you don't really care about currency don't be too greedy that you want to take all the gains out there just invest let the money compound buy good businesses buy assets because in general holding currencies and think thinking about currencies is a losing game because currencies will and always lose value go to zero and compared in the long term so think about that when it comes to investing focus on businesses focus on buying great assets and that's all what we do on this channel so please subscribe for stock analysis for finding great businesses and investing for the long term and let our and to let our returns compound over infinity that's it not currencies businesses thank you looking forward to your comments are you an international investor are you afraid of currencies please share that i always like to get new ideas for videos in your 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