Time to Hedge USD in EM Local Currency Bond Exposure
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
Insights
Fixed Income
Time to Hedge USD in EM
Q1 2021 Local Currency Bond Exposure
James Binny
Global Head of Currency
State Street Global Advisors
Mandy Chiu, CFA
Head of EMEA/APAC SPDR Product
SPDR ETFs
Simon Hutcheson, CFA
Senior Product Developer
SPDR ETFs
• Given that currency can contribute significantly to
the risk of emerging market local currency bonds,
investors need to consider whether or not to hedge
their currency exposure.
• It is possible accept the exposure to undervalued
emerging market currencies while removing the
exposure to US dollar.
Currency Currency represents a substantial amount of the risk in emerging market local currency
Considerations for bonds. For instance, since 2010, the historical volatility of the Barclays Bloomberg EM Local
Currency Liquid Index has been 10.6%. The volatility of the currency component alone is 7.2%,
Investors in Emerging
so over 67% of the risk can be due to currency.1 This means that accepting or removing the
Market Local currency exposure can be an important decision when investing in emerging markets.
Currency Bonds
The currency risk can be split into two parts:
• The risk of emerging market currencies: arguably, currency provides part of the risk
premium investors are seeking when investing in emerging markets. These currencies can
also be expensive to hedge.
• US dollar (USD) risk: most emerging market currencies are measured against the USD —
indeed, many emerging market monetary authorities and governments explicitly manage
their currencies against the USD.
Therefore, if an investor’s base currency is something other than USD, an investment in
emerging market local fixed income can create exposure to both the emerging market
currencies and USD. It is not necessarily the case that both emerging market currencies
and USD are appealing at the same time.SPDR Bloomberg Barclays Emerging Markets Local Bond USD Base CCY Hdg to EUR UCITS
ETF1 employs a “base currency hedging” methodology, where only the base currency of the
portfolio is hedged. Thus it enables investors to accept the emerging market currency risk
without also being burdened by USD risk. This differs from the majority of currency hedging
methodologies, which employ “portfolio hedging,” where underlying portfolio currencies are
hedged (for further information on methodologies, please see the table on page 4).
Are Emerging Market In USD terms, according to estimates from State Street Global Advisors, the currencies in the
Currencies Currently Barclays Bloomberg EM Local Currency Liquid Government Index are undervalued by -3.4%
(as at 31 January 2021). That does not mean that they cannot fall further (the same currencies
Good Value?
became -21.5% undervalued in March 2001).
However, as Figure 1 shows, the same emerging market currency basket is a long way from the
peak of 27.8% before the Global Financial Crisis or 19.0% before the Taper Tantrum in 2013.
On that basis, we believe emerging market local bonds look relatively attractive on a long-term
basis, especially when combined with the enhanced yield on the index (3.68% yield to worst as
at 31 January 2021, according to Bloomberg).
Figure 1 40 Currency Overvaluation Against USD (%)
Valuation of GFC 27.8%
30
Emerging Market Taper Tantrum 19.0%
Currencies 20
Against USD
10
0
-10
31-Jan 2021
-20
-3.4%
-30
Jan Oct Jul Apr Jan
1990 1997 2005 2013 2021
Source: Bloomberg Finance L.P., State Street Global Advisors, as of 31 January 2021.
Most emerging markets are considered relative to USD and many of the currencies are
managed relative to USD. However, as discussed above, if an investor has a different currency
base, then the value of USD also matters. Is it possible to make a similar valuation case in
EUR or GBP? As Figure 2 shows, a similar pattern can be observed and emerging market
currencies are cheaper than in 2008 or 2013. Nevertheless, the undervaluation may be
less compelling — in the case of GBP emerging market currencies appear overvalued by a
considerable amount; EUR is closer to fair value but such moves have overshot in the past as
the chart shows.
So here is the challenge: emerging market currencies are cheap relative to USD but expensive
for GBP and around fair value for EUR investors. To express this another way, USD is
expensive relative to not only emerging market currencies, but also EUR and GBP.
Investors do not necessarily want to accept more USD exposure with an emerging market
exposure, especially when developed market equity portfolios are often already biased
towards the USD.
Time to Hedge USD in EM Local Currency Bond Exposure 2Figure 2 40 Emerging Market Currency Overvaluation (%)
Valuation of
30
Emerging Market
Currencies Against 20
EUR and GBP
10
Barc Bloomberg EM
Local Currency vs GBP 0
Barc Bloomberg EM
Local Currency vs EUR -10
-20
-30
Jan Oct Jul Apr Jan
1990 1997 2005 2013 2021
Source: Bloomberg Finance L.P., State Street Global Advisors, as of 31 January 2021.
SPDR Bloomberg Barclays Emerging Markets Local Bond USD Base CCY Hdg to EUR
UCITS ETF tries to make sense of these valuation differences by obtaining exposure to the
undervalued emerging market currencies without being exposed to the overvalued USD.
Looking at Figure 3, which shows the value of USD relative to EUR and GBP (i.e. excluding any
emerging market impact), it is possible to see that currency valuations rise and fall according
to estimates from State Street Global Advisors. But ultimately, historically they have not only
returned to fair value, but also overshot on the other side (i.e. the figures cross over the 0% line
on many occasions).
Common sense seems to imply that investors might be better off not accepting the USD risk
when it is towards the top end of valuations (conversely, one might want to switch into the
unhedged version of the ETF when the dollar is undervalued). It is worth noting the timescale
on the figure — currency valuations can take time to revert, but from a long-term perspective,
reversion to the mean has always occurred.
What is clear from the figures is that the USD would currently appear slightly overvalued
against EUR and more significantly against GBP. Now may be an opportune time to hedge
USD exposure using a base currency hedged ETF.
Figure 3 50 Overvaluation of US Dollar (%)
Valuation of USD
40
Currencies Against
EUR and GBP 30
20
USD vs EUR
USD vs GBP 10
0
-10
-20
-30
Feb Mar May Jul Sep Nov Jan
1990 1995 2000 2005 2010 2015 2021
Source: Bloomberg Finance L.P., State Street Global Advisors, as of 31 January 2021.
Time to Hedge USD in EM Local Currency Bond Exposure 3Figure 4 Hedging Base Currency Hedging Portfolio Hedging
Methodology
Base Currency Hedging
vs. Portfolio Hedging Also known as “NAV hedging” or “share class hedging” “Full-look-through hedging”
Description Base currency hedged share classes Portfolio hedging means that any currency
simply hedge the currency risk of the share exposures other than the base (share class)
class relative to the fund’s base currency. currency are hedged. In this way, the value of
Consequently, the value of the fund in its share the fund in its share class currency is protected
class currency is protected from currency from currency fluctuations.
fluctuations between the share class and the
fund’s base currency but not from any other For these hedged shares classes, typically most
underlying currency exposure. currencies in the portfolio are hedged into the
share class currency, minimising unhedged
For these hedged share classes, currencies in currency exposures.
the portfolio are not hedged into the share class
currency, leaving exposures to the underlying This approach involves entering into several
currencies unhedged. one-month FX forward contracts to sell each
currency in the portfolio in exchange for receipt
This approach involves selling a one-month FX of the share class currency.
forward contract of the fund’s base currency in
exchange for the currency of the share class. The majority of hedged classes offered by
SPDR ETFs implement portfolio hedging.
Example SPDR ETF SPDR Bloomberg Barclays Emerging SPDR Bloomberg Barclays Global Aggregate
Markets Local Bond USD Base CCY Hdg to Bond EUR Hdg UCITS ETF3
EUR UCITS ETF2
SPDR Refinitiv Global Convertible Bond EUR
Hdg UCITS ETF4
Source: State Street Global Advisors, as of 30 November 2019.
Endnotes 1 Source: Bloomberg Finance L.P., State Street Global 3 USD, GBP, CHF and SGD hedged share classes
Advisors, as of 31 January 2021. also available.
2 GBP and CHF hedged classes also available. 4 USD, GBP and CHF hedged share classes
also available.also available.
ssga.com/etfs documents that the Companies must accordance with article L214- 2-2 of the Secteur Financier in Luxembourg in order to
publish in Ireland pursuant to applicable French Monetary and Financial Code. market its shares for sale to the public in
Marketing Communication. General Irish law are translated into Finnish and Germany: The offering of SPDR ETFs by Luxembourg and the Companies are notified
Access. For professional client use only. are available for Finnish investors by the Companies has been notified to Undertakings in Collective Investment for
For qualified investors according to contacting State Street Custodial Services the Bundesanstalt für Transferable Securities (UCITS).
Article 10(3) and (3ter) of the Swiss (Ireland) Limited, 78 Sir John Rogerson’s Finanzdienstleistungsaufsicht (BaFin) in Netherlands: This communication is
Collective Investment Schemes Act Quay, Dublin 2, Ireland. accordance with section 312 of the German directed at qualified investors within the
(“CISA”) and its implementing France: This document does not constitute Investment Act. Prospective investors meaning of Section 2:72 of the Dutch
ordinance, at the exclusion of qualified an offer or request to purchase shares in may obtain the current sales Prospectuses, Financial Markets Supervision Act (Wet op
investors with an opting-out pursuant to the Companies. Any subscription for shares the articles of incorporation, the KIIDs as het financieel toezicht) as amended.
Art. 5(1) of the Swiss Federal Law on shall be ade in accordance with the terms well as the latest annual and semiannual The products and services to which this
Financial Services (“FinSA”) and without and conditions specified in the complete report free of charge from State Street communication relates are only available
any portfolio management or advisory Prospectuses, the KIID, the addenda as well Global Advisors GmbH, Brienner Strasse 59, to such persons and persons of any other
relationship with a financial as the Companies’ Supplements. These D-80333 Munich. T: +49 (0)89-55878-400. description should not rely on this
intermediary pursuant to Article 10(3ter) documents are available from the Company Ireland: State Street Global Advisors Ireland communication. Distribution of this
CISA (“Excluded Qualified Investors”) centralising correspondent: State Street Limited is regulated by the Central Bank of document does not trigger a licence
only. Banque S.A., 23-25 rue Delariviere- Ireland. Registered office address 78 Sir requirement for the Companies or SSGA
Lefoullon, 92064 Paris La Defense Cedex John Rogerson’s Quay, Dublin 2. Registered in the Netherlands and consequently no
Austria: The offering of SPDR ETFs by the or on the French part of the site spdrs.com. number 145221. T: +353 (0)1 776 3000. prudential and conduct of business
Company has been notified to the Financial The Companies re undertakings for collective F: +353 (0)1 776 3300. supervision will be exercised over the
Markets Authority (FMA) in accordance investment in transferable securities (UCITS) Italy: State Street Global Advisors Ireland Companies or SSGA by the Dutch Central
with section 139 of the Austrian Investment governed by Irish law and accredited by the Limited, Milan Branch (Sede Secondaria di Bank (De Nederlandsche Bank N.V.) and
Funds Act. Prospective investors may Central Bank of Ireland as a UCITS n Milano) is a branch of State Street Global the Dutch Authority for the Financial
obtain the current sales Prospectus, the accordance with European Regulations. Advisors Ireland Limited, registered in Ireland Markets (Stichting Autoriteit Financiële
articles of incorporation, the KIID as well as European Directive no. 2014/91/ EU dated with company number 145221, authorised and Markten). The Companies have completed
the latest annual and semi-annual report 23 July 2014 on UCITS, as amended, regulated by the Central Bank of Ireland, and their notification to the Authority Financial
free of charge from State Street Global established common rules pursuant to the whose registered office is at 78 Sir John Markets in the Netherlands in order to
Advisors GmbH, Brienner Strasse 59, cross-border marketing of UCITS with which Rogerson’s Quay, Dublin 2. State Street Global market their shares for sale to the public in
D-80333 Munich. T: +49 (0)89-55878-400. F they duly comply. This common base does Advisors Ireland Limited, Milan Branch (Sede the Netherlands and the Companies are,
+49 (0)89-55878-440. not exclude differentiated implementation. Secondaria di Milano), is registered in Italy accordingly, investment institutions
Finland: The offering of funds by the This is why a European UCITS can be sold in with company number 10495250960 - R.E.A. (beleggingsinstellingen) according to
Companies has been notified to the Financial France even though its activity does not 2535585 and VAT number 10495250960 Section 2:72 Dutch Financial Markets
Supervision Authority in accordance with comply with rules identical to those and whose office is at Via Ferrante Aporti, Supervision Act of Investment Institutions.
Section 127 of the Act on Common Funds governing the approval of this type of 10 - 20125 Milano, Italy. T: +39 02 32066 100. Norway: The offering of SPDR ETFs by
(29.1.1999/48) and by virtue of confirmation product in France. The offering of these F: +39 02 32066 155. the Companies has been notified to the
from the Financial Supervision Authority compartments has been notified to the Luxembourg: The Companies have been Financial Supervisory Authority of Norway
the Companies may publicly distribute their Autorité des Marchés Financiers (AMF) in notified to the Commission de Surveillance du (Finanstilsynet) in accordance with
Shares in Finland. Certain information and
Time to Hedge USD in EM Local Currency Bond Exposure 4applicable Norwegian Securities Funds are only available to such persons and The views expressed in this material are the CALCULATION OF THE EQUATION BY WHICH
legislation. By virtue of a confirmation letter persons of any other description should views of SPDR Product through the period THE PRODUCT(S) IS TO BE CONVERTED INTO
from the Financial Supervisory Authority not rely on this communication. Many of the ending 31 January 2021 and are subject to CASH. REFINITIV HAS NO OBLIGATION OR
dated 28 March 2013 (16 October 2013 for protections provided by the UK regulatory change based on market and other conditions. LIABILITY IN CONNECTION WITH THE
umbrella II) the Companies may market and system do not apply to the operation of This document contains certain statements ADMINISTRATION, MARKETING OR TRADING
sell their shares in Norway. the Funds, and compensation will not be that may be deemed forward-looking OF THE PRODUCT(S).
Spain: State Street Global Advisors SPDR available under the UK Financial Services statements. Please note that any such REFINITIV DOES NOT GUARANTEE THE
ETFs Europe I and II plc have been authorised Compensation Scheme. statements are not guarantees of any future QUALITY, ACCURACY AND/OR THE
for public distribution in Spain and are performance and actual results or COMPLETENESS OF THE INDEX OR ANY DATA
registered with the Spanish Securities Important Information developments may differ materially from INCLUDED THEREIN. REFINITIV MAKE NO
Market Commission (Comisión Nacional del those projected. WARRANTY, EXPRESS OR IMPLIED, AS TO
Mercado de Valores) under no.1244 and This document has been issued by State Past performance is not a guarantee of RESULTS TO BE OBTAINED BY LICENSEE,
no.1242. Before investing, investors may Street Global Advisors Ireland (“SSGA”), future results. OWNERS OF THE PRODUCT(S), OR ANY
obtain a copy of the Prospectus and Key regulated by the Central Bank of Ireland. Investing involves risk including the risk of OTHER PERSON OR ENTITY FROM THE USE
Investor Information Documents, the Registered office address 78 Sir John loss of principal. OF THE INDEX OR ANY DATA INCLUDED
Marketing Memoranda, the fund rules or Rogerson’s Quay, Dublin 2. Registered THEREIN IN CONNECTION WITH THE RIGHTS
instruments of incorporation as well as the number 145221. T: +353 (0)1 776 3000. Investments in emerging or developing LICENSED HEREUNDER OR FOR ANY OTHER
annual and semi-annual reports of State F: +353 (0)1 776 3300. markets may be more volatile and less liquid USE. REFINITIV MAKE NO EXPRESS OR
Street Global Advisors SPDR ETFs Europe than investing in developed markets and may IMPLIED WARRANTIES, AND HEREBY
I and II plc from Cecabank, S.A. Alcalá 27, SPDR ETFs is the exchange traded funds involve exposure to economic structures that EXPRESSLY DISCLAIM ALL WARRANTIES
28014 Madrid (Spain) who is the Spanish (“ETF”) platform of State Street Global are generally less diverse and mature and to OF MERCHANTABILITY OR FITNESS FOR
Representative, Paying Agent and distributor Advisors and is comprised of funds that have political systems which have less stability A PARTICULAR PURPOSE OR USE WITH
in Spain or at spdrs.com. The authorised been authorised by Central Bank of Ireland as than those of more developed countries. RESPECT TO THE INDEX OR ANY DATA
Spanish distributor of State Street Global open-ended UCITS investment companies. Investing in foreign domiciled securities may INCLUDED THEREIN. WITHOUT LIMITING
Advisors SPDR ETFs is available on the State Street Global Advisors SPDR ETFs involve risk of capital loss from unfavourable ANY OF THE FOREGOING, IN NO EVENT
website of the Securities Market Commission Europe I & SPDR ETFs Europe II plc issue SPDR fluctuation in currency values, withholding SHALL REFINITIV HAVE ANY LIABILITY
(Comisión Nacional del Mercado de Valores). ETFs, and is an open-ended investment taxes, from differences in generally accepted FOR ANY SPECIAL, PUNITIVE, INDIRECT,
company with variable capital having accounting principles or from economic or INCIDENTAL OR CONSEQUENTIAL DAMAGES
For Investors in Switzerland: This segregated liability between its sub-funds. political instability in other nations. OR LOST PROFITS, EVEN IF NOTIFIED OF THE
document is directed at qualified investors The Company is organised as an Undertaking Standard & Poor’s, S&P and SPDR are POSSIBILITY OF SUCH DAMAGES.
only, as defined Article 10(3) and (3ter) of the for Collective Investments in Transferable registered trademarks of Standard & Poor’s Prior to 29 May 2020, the Fund was known as
Swiss Collective Investment Schemes Act Securities (UCITS) under the laws of Ireland Financial Services LLC (S&P); Dow Jones is a SPDR® Thomson Reuters Global Convertible
(“CISA”) and its implementing ordinance, at and authorised as a UCITS by the Central registered trademark of Dow Jones Bond UCITS ETF (Dist).
the exclusion of qualified investors with an Bank of Ireland. Trademark Holdings LLC (Dow Jones); and The whole or any part of this work may not be
opting-out pursuant to Art. 5(1) of the Swiss The information provided does not these trademarks have been licensed for use reproduced, copied or transmitted or any of its
Federal Law on Financial Services (“FinSA”) constitute investment advice as such by S&P Dow Jones Indices LLC (SPDJI) and contents disclosed to third parties without
and without any portfolio management or term is defined under the Markets in sublicensed for certain purposes by State SSGA’s express written consent.
advisory relationship with a financial Financial Instruments Directive Street Corporation. State Street Corporation’s Bonds generally present less short-term risk
intermediary pursuant to Article 10(3ter) CISA (2014/65/EU) or applicable Swiss financial products are not sponsored, and volatility than stocks, but contain interest
(“Excluded Qualified Investors”). Certain of the Regulator and it should not be relied on endorsed, sold or promoted by SPDJI, Dow rate risk (as interest rates raise, bond prices
funds may not be registered for public sale as such. It should not be considered a Jones, S&P, their respective affiliates and third usually fall); issuer default risk; issuer credit
with the Swiss Financial Market Supervisory solicitation to buy or an offer to sell any party licensors and none of such parties make risk; liquidity risk; and inflation risk. These
Authority (FINMA) which acts as supervisory investment. It does not take into account any any representation regarding the advisability effects are usually pronounced for longer-term
authority in investment fund matters. investor’s or potential investor’s particular of investing in such product(s) nor do they securities. Any fixed income security sold or
Accordingly, the shares of those funds may investment objectives, strategies, tax status, have any liability in relation thereto, including redeemed prior to maturity may be subject to
only be offered to the aforementioned risk appetite or investment horizon. If you for any errors, omissions, or interruptions of a substantial gain or loss.
qualified investors and not be offered to any require investment advice you should consult any index. Government bonds generally have more
other investor in or from Switzerland. Before your tax and financial or other professional THE SPDR REFINITIV GLOBAL CONVERTIBLE moderate short-term price fluctuations
investing please read the prospectus and the advisor. All information is from SSGA unless BOND UCITS ETF (THE “PRODUCT”) IS than stocks, but provide lower potential
KIID. In relation to those funds which are otherwise noted and has been obtained from NOT SPONSORED, ENDORSED, SOLD OR long-term returns.
registered with FINMA or have appointed a sources believed to be reliable, but its PROMOTED BY REFINITIV LIMITED OR ANY The information contained in this
Swiss Representative and Paying Agent, accuracy is not guaranteed. There is no OF ITS SUBSIDIARIES OR AFFILIATES communication is not a research
prospective investors may obtain the current representation or warranty as to the current (“REFINITIV”). REFINITIV MAKE NO recommendation or ‘investment
sales prospectus, the articles of incorporation, accuracy, reliability or completeness of, nor REPRESENTATION OR WARRANTY, EXPRESS research’ and is classified as a ‘Marketing
the KIIDs as well as the latest annual and liability for, decisions based on such OR IMPLIED, TO THE OWNERS OF THE Communication’ in accordance with the
semi-annual reports free of charge from the information and it should not be relied on PRODUCT(S) OR ANY MEMBER OF THE Markets in Financial Instruments
Swiss Representative and Paying Agent, State as such. PUBLIC REGARDING THE ADVISABILITY OF Directive (2014/65/EU) or applicable
Street Bank International GmbH, Munich, ETFs trade like stocks, are subject to INVESTING IN SECURITIES GENERALLY OR IN Swiss Regulation. This means that this
Zurich Branch, Beethovenstrasse 19, 8027 investment risk and will fluctuate in market THE PRODUCT(S) PARTICULARLY OR THE marketing communication (a) has not
Zurich, or at ssga.com, as well as from the value. The investment return and principal ABILITY OF THE REFINITIV QUALIFIED been prepared in accordance with legal
main distributor in Switzerland, State Street value of an investment will fluctuate in value, GLOBAL CONVERTIBLE INDEX (THE “INDEX”) requirements designed to promote the
Global Advisors AG (“SSGA AG”), so that when shares are sold or redeemed, TO TRACK GENERAL MARKET independence of investment research
Beethovenstrasse 19, 8027 Zurich. For they may be worth more or less than when PERFORMANCE. REFINITIV’ ONLY (b) is not subject to any prohibition on
information and documentation regarding all they were purchased. Although shares may be RELATIONSHIP TO THE PRODUCT(S) AND dealing ahead of the dissemination of
other funds, please visit spdrs.com or contact bought or sold on an exchange through any STATE STREET GLOBAL ADVISORS (THE investment research.
SSGA AG. brokerage account, shares are not individually “LICENSEE”) IS THE LICENSING OF THE INDEX, You should obtain and read the SPDR
redeemable from the fund. Investors may WHICH IS DETERMINED, COMPOSED AND prospectus and relevant Key Investor
For Investors in the UK: The Funds have acquire shares and tender them for CALCULATED BY REFINITIV OR ITS Information Document (KIID) prior to
been registered for distribution in the UK redemption through the fund in large LICENSORS WITHOUT REGARD TO THE investing, which may be obtained from
pursuant to the UK’s temporary permissions aggregations known as “creation units.” Please LICENSEE OR THE PRODUCT(S). REFINITIV spdrs.com. These include further details
regime under regulation 62 of the Collective see the fund’s prospectus for more details. HAS NO OBLIGATION TO TAKE THE NEEDS relating to the SPDR funds, including
Investment Schemes (Amendment etc.) (EU BLOOMBERG®, a trademark and service mark OF THE LICENSEE OR THE OWNERS OF information relating to costs, risks and
Exit) Regulations 2019. The Funds are directed of Bloomberg Finance L.P. and its affiliates, THE PRODUCT(S) INTO CONSIDERATION where the funds are authorised for sale.
at ‘professional clients’ in the UK (as defined in and BARCLAYS®, a trademark and service IN CONNECTION WITH THE FOREGOING.
rules made under the Financial Services and mark of Barclays Bank Plc, have each been REFINITIV IS NOT RESPONSIBLE FOR © 2021 State Street Corporation.
Markets Act 2000) who are deemed both licensed for use in connection with the listing AND HAS NOT PARTICIPATED IN THE All Rights Reserved.
knowledgeable and experienced in matters and trading of the SPDR Bloomberg DETERMINATION OF THE TIMING OF, PRICES ID411469-2872625.2.1.EMEA.INST 0321
relating to investments. The products and Barclays ETFs. AT, OR QUANTITIES OF THE PRODUCT(S) TO Exp. Date: 31/03/2022
services to which this communication relates BE ISSUED OR IN THE DETERMINATION OR
Time to Hedge USD in EM Local Currency Bond Exposure 5You can also read
