You will be able to explain how a currency move changes the Singapore dollar return on a foreign investment.
Jasmine holds a fund that invests in US shares. One year the fund's factsheet reported a return of 8%, and she was pleased until she checked her own account, which showed a loss. She assumed something had gone wrong with the platform. Nothing had. The fund was priced in US dollars, and over the same year the US dollar had fallen against the Singapore dollar. The fund did well in its own currency and badly in hers.
If you invest outside Singapore, there are always two returns going on at once: the investment's and the currency's. This lesson shows how they combine, what hedging does, and where the bigger decisions belong.
Your return in Singapore dollars depends on what the investment did in its own currency, and on what that currency did against the Singapore dollar. As a rough rule, add them: an 8% gain in US dollars and a 10% fall in the US dollar against the Singapore dollar gives roughly minus 2%.
The exact figure comes from multiplying rather than adding, because the currency move applies to your gains as well as to your original money, and a worked example with made-up figures shows the difference.
Jasmine invested US$10,000 when one US dollar cost S$1.35, so she paid S$13,500. Over the year the fund rose 8%, to US$10,800.
If the US dollar falls 10% against the Singapore dollar, to S$1.215, her US$10,800 is worth S$13,122. Her return in Singapore dollars is 13,122 divided by 13,500, minus one, which is minus 2.8%. The rough rule said minus 2%. The difference is the currency fall applied to her 8% gain.
If instead the US dollar rises 10%, to S$1.485, her US$10,800 is worth S$16,038, a return of 18.8%. The rough rule said 18%.
If the exchange rate does not move, she earns the fund's 8%.
So the same fund, in the same year, could have returned anything from minus 2.8% to 18.8% for a Singapore investor, and the currency alone made the difference. For small moves the rough rule is close enough. For large ones, multiply. In a spreadsheet, it is (1 + investment return) x (1 + currency move) - 1.
Some funds offer a hedged share class: the same fund, with contracts added that offset most of the currency effect. A Singapore dollar hedged version of Jasmine's fund would aim to give her roughly the fund's US dollar return, whatever the US dollar does against the Singapore dollar.
The contracts are usually forward contracts, agreements to exchange currencies at a set rate in the future, rolled over regularly, and someone has to pay for them. What they cost depends mainly on the gap between the interest rates of the two currencies, plus the fund's own charges for running the hedge. When US rates are well above Singapore rates, hedging US dollar assets back into Singapore dollars typically costs about that gap each year. In the example, if hedging cost 1.5% a year, the hedged version would have returned about 6.5% instead of 8%, in every scenario.
So a hedge trades away the chance of a currency gain to remove the chance of a currency loss, and it charges you for the trade. The hedge covers the currency and nothing else, so if the shares themselves fall, the hedged class falls with them.
Not every fund offers a hedged class. Some investments, such as shares you buy directly on a foreign exchange, carry the full currency effect unless you hedge separately.
Over very long periods, currency moves between major economies have tended to partly cancel out, because a currency that falls a long way makes that country's goods cheaper and draws buyers back. Over a few years, though, a currency can move far enough to add or remove a large share of what the investment earned, and a year like Jasmine's is quite ordinary.
That is why the time horizon matters. Money you will need in two or three years, in Singapore dollars, is more exposed to an unlucky currency swing than money you will hold for decades.
How much of a portfolio to hold in foreign assets, and how much of that to hedge, is a portfolio decision. It depends on your other holdings, what currency you will spend the money in, and how much volatility you can live with. That is taught in Investing Like an Institution. This course does not tell you what to buy, and nothing here is a reason to choose hedged or unhedged on its own.
What you need from this lesson is the arithmetic. Take one foreign investment you hold or are thinking about, and its return in its own currency, and see what a 10% currency move in each direction would have done to it in Singapore dollars.
For one foreign investment you hold or are considering, work out its Singapore dollar return if the currency had risen or fallen by 10%.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).