Archive for April, 2015

Should You Currency Hedge Stock and Bond Funds?

Monday, April 27th, 2015
  • Foreign bonds are almost always better to currency hedge so they can serve fulfill their volatility moderation role
  • Foreign stocks are generally best hedged in retirement, and may be better unhedged during long-term periodic accumulation
  • Currency exposure is best pursued directly in FX or currency futures contracts

On balance, Dollar-based investors owning foreign assets hedged back to the Dollar is generally a good idea.

In the case of bonds, we think currency hedging is virtually always a good idea.

In the case of stocks, we think it is typically a good idea, unless you believe you have the time and skill to switch back and forth profitably between hedged and non-hedge stocks — and that you have the discipline and emotional strength and consistency to deal with the whipsaws that come with that approach.  Alternatively, you may find actively managed funds that effectively adjust their portfolio back and forth between hedged and unhedged.

For those in the accumulation stage with long-time horizons and doing Dollar-Cost-Averaging; the extra volatility of unhedged foreign equities could be an advantage.  Volatility is helpful with regular periodic investing, and harmful with regular, periodic withdrawal.  Therefore, retirees are better served by the volatility reduction that Dollar hedging is supposed to provide.

The array of hedge funds has proliferated and a review of unhedged fund substitution with hedged funds  for suitability is advisable

Hedging Equities:

Currency hedging equities is a two-edged sword. When the dollar is rising, hedged funds outperform unhedged funds. When the dollar is falling, hedged funds underperform unhedged funds.

There have been prolonged periods where one approach or the other has been superior, but in the very long-term the currency effect may be a wash.

These two charts based on MSCI indexes (one for EuroZone stocks and one for Japanese stocks) show the cumulative and monthly return differences from 1999 through March 2015:


You can see from these charts that the monthly returns (thin gray lines) vary wildly. The cumulative return differences (blue and orange lines) can have periods of several years of differential performance of hedged versus local currency returns.  Even though there are substantial periods of differential performance, the volatility is so significant, that whipsaws are a real impediment for many investors who wish to ride the currency trends by switching between hedging and not hedging.

Vanguard said in  “To Hedge or Not To Hedge: Evaluating currency exposure in global equity portfolios” published in September 2014:

“A reasonable forward-looking assumption is for an unhedged and a hedged investment to produce similar gross  returns over long time horizons.”

But that is over the long-term.  Over shorter periods of a year or two or three, for example, the choice to hedge or not hedge is quite material.

Hedging reduces one source of volatility (currency exchange rates at the portfolio level), but leaves unmodified the volatility of foreign stock expressed in the local currency; and the effect of currency exchange rates on the internal financial operations of the stocks in the portfolio.

Global Company Question:

For global giants currency effect is hard to pin down.  Major US companies may be massively exposed to foreign exchange; and foreign domiciled companies may do large portions of their operations in the US or in Dollars.

Global multi-national companies may be doing a substantial amount of currency hedging internally.

For a concentrated portfolio of global multi-national companies, the question of currency hedging at the portfolio level many be a more debatable one.

Dollar, Euro and Yen – The Three Major Currencies

The three major world currencies in terms of foreign exchange trading are the Dollar, the Euro and the Yen. These charts show the performance of the Euro and the Yen versus the Dollar over 16 years and 3 months.

FX1999 FX 3mo

From 2002 through 2004, with the Yen (red) rising versus the Dollar, if you chose to invest in Japan, you would have done better with an unhedged Japanese equities fund such as EWJ, instead of a hedged fund such as HEWJ available today. Then for 2005 through the middle of 2007, the Yen was falling and you would have done better with a hedged Japan stocks fund. From last 2012 through just recently as the Yen was falling, you would have done better with a hedged Japan fund such as recently available HEWJ.

Similarly, from 2002 through 2004 with the Euro rising versus the Dollar, if you chose to invest in the Euro Zone countries, you would have done better owning an unhedged fund such as the Germany ETF (EWG). However, from the 2008 crash through today, the Euro has been on a volatile up and down ride versus the Dollar, and you needed to switch back and forth several times to be on the right side of the currency trends. Over the past year, a hedged Germany fund, such as HEWG would have been the superior performer.

With Dollar Cost Averaging Unhedged Equities May Be Better:

Of note for investors with long-term horizons, particularly those doing regular periodic dollar-cost average investing; there would have been little benefit of seeking hedges. As you can see over periods of 10 and 15 years, currency effect can amount to virtually nothing. And, those doing dollar cost average with an unhedged fund would have benefited by the volatility and peaks and troughs along the way.

Hedging Was a Winner Over The Past 12 Months:

The top 1 year chart below shows  the performance of the unhedged Germany ETF (EWG), the hedged Germany ETF (HEWG) and the Euro exchange rate versus the Dollar (FXE).  The bottom 1 year chart below shows the unhedged Japan ETF (EWJ) and the hedged Japan ETF (HEWJ) and the Yen exchange rate versus the Dollar (FXY).

They both show the substantial outperformance of the hedged approach during that time period.


Hedging of Marginal Value Last Few Months:

Over the last 3 months, however,  both the Euro and the Yen seem to have stabilized against the Dollar. Over 3 months hedging showed no advantage, and in fact a slight disadvantage to owning the hedged equity funds.

HEDGE 3 mo

If the current generally flat exchange rate performance of the Euro and the Yen is to continue, or is harbinger of a weakening of the Dollar, then the unhedged forms of the Germany and Japan equities (EWG and EWJ) would be the superior choice for those moving between hedged and unhedged.

With QE increasing abroad and the Fed moving away from QE, an argument can be made that further Dollar strength is ahead, and that hedged equity funds are a better choice for total return. The consensus is that the Dollar has more strengthening ahead. How far and how long the Dollar will rise is, of course, uncertain.

Which Way To Go?

If you are young and Dollar-Cost Averaging, consider using unhedged equity funds.

If you are retired and withdrawing assets (without excess assets), consider using hedged equity funds.

If you are good enough with calling trend reversals (as opposed to volatility noise) and can live with a certain percentage of decisions being wrong due to whipsaw markets, then moving between hedged and unhedged investments may be suitable for you.

If you are a Dollar based investor and will not chastise yourself for sticking with Dollar investments when unhedged assets outperform, then stay with hedged funds.

If you don’t have a view, and aren’t one of the above, it may make sense to split the baby – 50% of international stocks hedged and 50% unhedged.

Foreign Bonds Are A Different Matter:

With foreign bonds hedging is a more clear-cut decision, unless you actually want to trade currency, but then you might be better off doing that directly in the FX or futures markets.  U.S. investors are likely to want bonds in their portfolio to reduce overall volatility, and/or also to match certain Dollar denominated capital expense or periodic withdrawals intentions.  Hedging helps realize those goals.

Currency risk significantly increases bond portfolio volatility — that’s a bad thing for most investors who buy bond funds.

This 10-year chart of the PIMCO foreign bond fund hedged (red) and unhedged (black) shows the volatility dampening effect of hedging.


Vanguard makes the point that international bond funds should be hedged all the time.  They said this in an interview on their website “Total International Bond Index Fund: Why and How We Hedge” (June 17, 2013):

“Foreign currency exposure by far dominates the volatility profile of international bonds. It accounts for about two-thirds of volatility. So currency hedging will minimize that currency volatility or currency risk.

This short-term chart showing the Vanguard international bond fund (BNDX) in gold versus the PIMCO hedged international bond fund (PFODX) and the PIMCO unhedged international bond fund (PFBDX) illustrates the point that currency creates the vast majority of volatility in a bond fund at a more granular level.  By including the Vanguard fund, it helps to show that the hedging effect is not something peculiar to PIMCO.


Vanguard goes on the say this about foreign bond hedging,

investors can isolate the interest rate and the credit risk and can maximize the diversification benefit that international bonds bring to their portfolio… [the portfolio] uses one-month forward currency exchange transactions, as the index is rebalanced the last business day of the month. 

There is a cost associated with currency hedging … Liquidity is crucial to keeping costs low…. Eighty percent of Vanguard’s Total International Bond Index Fund will consist of euros, Japanese yen, and British pound exposure. …those are three of the most liquid currencies in the world. … those currencies will be hedged back to the dollar, which is the most liquid currency in the world. So the cost of hedging… will be minimal.”


  • Bonds are best used when denominated in or hedged back to investor’s home currency — hedge all of the time
  • International bonds are a poor way to speculate on currency swings
  • Speculating in currency exchange rates is best accomplished directly with FX instruments, not piggy-back on bond or stock instruments
  • For stocks currency makes a significant difference over the short-term and intermediate-term, but over the long-term it pretty much a wash
  • For young investors in the accumulation stage of life, unhedged foreign equities may be preferable, but for investors in the withdrawal stage of life (without excess assets) hedged foreign equities are preferable.
  • You have to be effective at trend and trend reversal analysis to move back and forth between hedged and unhedged equities with satisfactory results.

US Sector Asset Flows vs Total Returns – Following The Money

Thursday, April 23rd, 2015
  • Energy and Healthcare have strongest relative asset flows among stock sectors
  • Energy sector appears to be in accumulation stage
  • Healthcare marches on
  • Info Technology shows above average asset flow strength, but less than Energy and Healthcare
  • Utilities sector may be in distribution stage

Asset flows can be indicators of developing strength or weakness of a fund, which sometimes confirms price movements and sometimes diverges from prices. If asset flows diverge from price patterns, there is a suggestion of a trend reversal in the prices.  While not diagnostic alone, divergence between price patterns and asset flow, should trigger further investigation of fundamental and technical factors. Let’s look at relative asset flows for MSCI US sectors as they have been realized through Vanguard sector ETFs.  Those ETFs obviously do not show all sector asset flows, they do show relative flows within the Vanguard sector family.  By focusing on relative asset flows, we think the Vanguard ETFs provide a reasonable window. Asset flows are net of asset performance. These are the symbols for the Vanguard ETFs based on the 10 MSCI Global Industry Classification Standard “GICS” system.

Vanguard Materials ETF (VAW)
Vanguard Consumer Discretionary ETF (VCR)
Vanguard Consumer Staples ETF (VDC)
Vanguard Energy ETF (VDE)
Vanguard Financials ETF (VFH)
Vanguard Information Technology ETF (VGT)
Vanguard Health Care ETF (VHT)
Vanguard Industrials ETF (VIS)
Vanguard Telecommunication Services ETF (VOX)
Vanguard Utilities ETF (VPU)

Figure 1 illustrates the relative flows using a red, yellow, green shading method for the preriods:

  • 2012 – March 2015
  • 12 months
  • 6 months
  • 3 months
  • 1 month

Healthcare showing strong flows is not at all surprising, given the strong price performance for a considerable time.  The surprise, if any, is the strong flows into the energy sector.  It looks like investors have seen long-term value in energy and have been putting money there.  Utilities have shown the weakest flows.

Figure 1:


Figure 2 shows the relative asset flows on a monthly basis from 2012.  Energy flows were relatively average until mid-2014, when they picked up the pace to strong relative flows. The energy asset flows began improving their relative strength in April 2014, and has a strong relative flow in May 2014.  By February 2015, energy accounted for 80% of asset flows within the 10 sectors, and was 43% in March (numeric data not show in Figure 2).

Figure 2:


Figure 3 plots the rolling 3-month asset flows to the energy sector in dollar terms versus the rolling 3-month total return.  This year, the asset flows into energy are stronger than the total return would led one to expect.  This is not a divergence, but it does suggest we may be in an accumulation stage, where quieter money is moving to the sectors.

Figure 3:


Figure 4 shows the energy the trend  (200-day average) is still down, but the price is rising short-term toward a cross of the trend; but still 23% below the total US stock market (VTI), as shown in the lower panel (energy ETF divided by total US stocks ETF). Given the way crude oil seems to have formed a base in the 40s (Figure 5), the strong relative asset flows in to energy seem to be reasonable.

Figure 4:


Figure 5 shows what seems to be a forming possibly a double bottom base for oil before moving up into the 50’s.  Much to go wrong, but the turn up in energy stock prices, oil prices and strong asset flows, suggests energy is currently an attractive opportunity.

Figure 5:


Figure 6 shows the 3-month asset flows and 3-month rolling returns for the healthcare sector.  It has been the best performing sector for some time, and the asset flows show a complementary, supportive pattern.  Unless the biotech sector is bubbly and pops or deflates, healthcare is probably still a good place to have assets.

Figure 6:


Figure 7 shows the lovely price chart for healthcare. What else can be said about that — it’s lovely.

Figure 7:


Figure 8 show flows and returns for information technology. The relative flows are above average, but not as strong as for energy and healthcare (see Figure 1).  The flows appear more up-down-up-down variable than for energy and healthcare.

Figure 8:


Figure 9 shows price variation that generally corresponds with the rise and fall of the asset flows, but much more dampened that for the flows.

Figure 9:


Figure 10 shows flows and returns for utilities.   It reveals more negative flows than the other sectors we have looked at so far, which themselves are in synch with the rolling returns.

Figure 10:


Figure 11 shows a price chart for utilities that is not consistent with the recent negative asset flows.  The prices are rather flat, while the flows are negative.  Is this a distribution phase?

Figure 11:


Figures 12 and beyond show asset flows, rolling returns and price patterns for the remaining sectors, which have asset flows which are neither relatively strong or weak, included here for completeness, but not the focus of this article.

Figure 12:


Figure 13:


Figure 14:


Figure 15:


Figure 16:


Figure 17:


Figure 18:


 Figure 19:


Figure: 20


 Figure 21:


Figure 22:


Figure 23:


21 of 138 REITs in Up Trends, 13 Beat VNQ

Sunday, April 19th, 2015
  • Examine 138 REITs for price trend up or down
  • 6 simple binary factors establish trend
  • 21 in up trend, and 13 outperform REIT index.

These 21 REITs out of 138 in the Reuters DataLink database are in up trends  (even if ever so slight in some cases).  They may or may not be attractive to you by other metrics, but if you prefer to invest in stocks that are rising instead of falling, this batch is a good one on which to focus further fundamental examination.

Articles by Brad Thomas, or other REIT oriented authors may be a good place to begin your research on names from this list that are of  interest to you.

Independent of any fundamental views, this is the list of REITs that are moving up to one degree or another.


An up trend in this instance is defined by a binary computer filter of the tilt the tip of several moving averages, and by the stacking of shorter moving averages above longer moving averages. By using a binary (Yes/NO?) set of selection criteria carried out with a computer, large numbers of securities can be quickly filtered to identify a list of prospects.

It’s faster than manual inspection and absolutely faithful to the filter criteria, whereas inspection by eye is prone to a certain amount of wishful thinking by giving names you know or like a bit more leeway than other names.  Once the binary filter reduces the universe, you can then use all the objective or subjective examination of the charts you like, as well as doing your deep dive into the business itself.

We used what might be called  Moving Average Slope and Stacking based on 6 binary Yes/No (1/0) measurements of the slope of the price chart as of Friday April 17, 2015 (shown below listed from most important parameter on top to least important on the bottom):

  • 12 mo direction (is the 12 month average now higher than 10 days ago? Y/N)
  • 3 month av / 12 mo av (is the 3 month average above the 12 mo average? Y/N)
  • 3 mo direction (is the 3 month average now higher than 10 days ago? Y/N)
  • 1 mo / 3 mo (is the 1 month average now higher than 10 days ago? Y/N)
  • 1 mo direction (is the 1 month average above the 3 month average? Y/N)
  • Price / 1 mo (is the last price above the 1 month average? Y/N)

The first 6 column in this image (header shaded gray) present the results of the 6 binary filter questions.  The top 21 of 138 REITs are presented in this image.

 (Click image to enlarge)


The additional columns provide supplemental objective chart information

Z-Scores: Z-12 mo, Z-3 mo and Z-1 mo present the number of standard deviations the price is from the corresponding 12 mo, 3 mo and 1 mo moving average prices. For Z-scores look out for +/- 2 or more, as being possibly too far from its average to be likely able to maintain that distance. Those >= 2 are shaded pink, and those >=1.80 <2 are shaded yellow.

Money Flow Index: MF14 presents the 14-day money flow index (a volume weighted version of the relative strength index — itself a measure of the tendency of the price to position itself within its average daily range).  For Money Flow values over 70 are seen as overbought, and under 30 as oversold). Values <=70 are shaded pink.

Directional Movement:  PDI(14)-MDI(14) indicates short-term trend direction. A positive number means more higher highs were generated than lower lows over 14 days; and a negative number means more lower lows were generated than higher highs. Positive directional movement equals the current high minus the prior high, if the number is positive. Minus (negative) directional movement equals prior low minus the current low. For each period directional movement is positive (plus) when the current high minus the prior high is greater than the prior low minus the current low; and directional movement is negative (minus) when the prior low minus the current low is greater than the current high minus the prior high. The positive and minus directional movements are each averaged over 14 days and then the difference is calculated for PDI(14)-MDI(14).

Average Directional Index Rating, ADXR(14): ADXR is a non-directional trend strength indicator, based on calculation using Positive and Minus Directional Movement data. It has values from 0 to 100.  Values above 25 are seen as indicating a “trending” price pattern, while values under 25 are seen as indicating a “non-tending” (rather sideways) price pattern.  ADXR shows short-term trend strength and PDI-MDI shows short-term trend direction.

Binary data and Z-scores in the table above were produced using custom formulas in Equis Metastock with data feed from Reuters; and the other data is based on “out of the box” indicators in Metastock. 

Note that Reuters adds suffixes to many securities to identify where they are traded.

13 Outperformed Vanguard Equity REIT ETF (VNQ):

These 13 REITS outperformed VNQ:


The 3 top performers among them were CONE, NRZ, and EXR, as this chart shows (also shows comparison with an investment grade corporate bond fund (in gold) since some investors have gravitated to REITs as bond alternatives in the past few years.

If you would care to have the full list of REITs to see how each REIT scored, it is available without charge to SeekingAlpha readers who opt into our email list for occasional investment commentaries. Send a request with “REITs 2015-04-17” in the subject line to <>. We will email you the Excel spreadsheet.

Individual Price Charts: Computer generated binary tabular data is wonderful for sorting through large numbers of securities, and to subject selection to a limited set of strict objective guidelines.  In the end, though, the human eye and brain need to look at the whole picture in a price chart with its enormous number of data points.

So here they are — charts for each of the 21 REITS, also showing the 200-day and 50-day exponential moving averages, and in the lower panel the ratio of the REIT price divided by the VNQ price.

Good hunting!

(Click images to enlarge)






Survey of Technical Condition and Portfolio Attributes of Key Bond Fund Types

Sunday, April 12th, 2015

There may seem to be a bewildering array of bond fund types. This survey of key bond types may help you chose which if any are appropriate for your particular circumstances and portfolio.

We looked at 24 types of bond funds in terms of price chart slope:

US Aggregate Bonds (BND)
US ST Bonds (BSV)
US IT Bonds (BIV)
US LT Bonds (BLV)
US ST Govt Bonds (VGSH)
US IT Govt Bonds (VGIT)
US LT Govt Bonds (VGLT)
US Extended Duration Govt Bnds (EDV)
US ST Corp Bonds (VCSH)
US IT Corp Bonds (VCIT)
US LT Corp Bonds (VCLT)
US HY Corp Bonds (HYG)
ST Natl Tax Exempt Bonds (VWSTX)
IT Natl Tax Exempt Bonds (VWIUX)
LT Natl Tax Exempt Bonds (VWLTX)
HY Natl Tax Exempt Bonds (VWAHX)
Total Foreign Bonds (hedged) (BNDX)
Global Ex US HY Bonds (Euro, Sterling, Loonie) (HYXU)
Emerg Mkt Dollar Bonds (VWOB)
Emerg Mkt HY Dollar Bonds (EMHY)
US Inflation Protected Treasuries (VTIP)
US Mortgage Backed Bonds (VMBS)
US Floating Rate Bank Loans (BKLN)
US Preferrred Stocks (PFF)

We included a preferred stocks ETF in the list of “bond” funds. because preferred stocks can be arguably said to be closer to bonds than to common equity in their characteristics; and in this period of very low interest rates preferred stocks have been adopted by many investors as bond substitutes in the search for yield.

Figure 1: Technical Condition of Key Bond Fund Types
(Click to enlarge)

The most basic form of chart analysis is a binary determination — is the  slope of the price pattern is UP or NOT

Figure 1 below includes 6 binary Yes/No (1/0) measurements of the slope of the price chart as of Friday April 10, 2015 (from most important on top of list and least important on bottom of list):

  • 12 mo direction (is the 12 month average now higher than 10 days ago? Y/N)
  • 3 month av / 12 mo av (is the 3 month average above the 12 mo average? Y/N)
  • 3 mo direction (is the 3 month average now higher than 10 days ago? Y/N)
  • 1 mo / 3 mo (is the 1 month average now higher than 10 days ago? Y/N)
  • 1 mo direction (is the 1 month average above the 3 month average? Y/N)
  • Price / 1 mo (is the last price above the 1 month average? Y/N)



We have highlighted those with all 6 binary answers as Yes (1) with a bold border.  Of the 24 (as of Friday April 10, 2015), 13 of the 24 has a “perfect” 6 binary YES (1) slope ratings:


Figure 1 also presents 4 other chart price pattern attributes:  12 mo, 3 mo and 1 mo Z-scores (number of standard deviations the price is from the corresponding moving average price); and the 14-day money flow index (a volume weighted version of the relative strength index — itself a measure of the tendency of the price to position itself within its average daily range).

For Z-scores look out for +/- 2 or more, as being possibly too far from its average to be likely able to maintain that distance.  For Money Flow (MFI14) values over 70 are seen as overbought, and under 30 as oversold).

This binary data was produced using custom formulas in Equis Metastock with data feed from Reuters.  Note that Reuters adds suffixes to many securities to identify where they are traded.

Figure 2: Bond Fund Type Rolling Returns, Trailing Yield and Expense Ratio
(Click to enlarge)

Note that some of the fund types have a 12 month trailing yield that is greater than the 12 month total return (returns are as of last month-end(.  That means the price declined (See high yield corporate bonds, short-term municipal bonds, emerging market Dollar denominated bonds, emerging market high yield bonds, inflation protected Treasury bonds, and floating rate bank loans).

No adjustment has been made to express municipal bond yields on an after-tax basis.  A 1-to-1 comparison of presented yield between taxable and tax-exempt bonds should not be made — rather an estimate of your pre-tax equivalent yield is up to you to estimate.


Figure 3: Bond Fund Type Spread to Aggregate Bonds, Duration and Credit Quality
(Click to enlarge)

Take note of the different credit qualities and average durations, not just the yields on the different fund types.


Also keep in mind that duration for a fund (note is called “average” duration) has potentially quite different implication in a period of changing interest rates when compared to a single bond with a the same duration. A bond fund of any particular average duration may not respond to interest rate changes in the same way that a single bond would do.  Similarly two bonds funds of the same average duration may respond differently as well

Consider these two hypothetical bond funds, each containing 10 individual bonds, and each bond fund having an average duration of 5.5 years.  The first fund has 10 bonds each with a duration of 5.5 years.  The second fund as 10 bond each with a different duration (1,2,3,4,5,6,7,8,9, and 10 years), also with an average duration of 5.5 years.

When interest rates change, and the shape of the yield curve changes, these two funds will no react to the same degree.

This is not even to consider the mix of credit qualities that might react differently due to perceived changes in credit risk that may be happening at the same time that interest rates are changing.  And, to the extent that the fund uses derivatives to emulate bonds, a liquidity crisis could create an entirely different ball game for those funds versus funds that only hold real bonds.

Figure 4 Bond Fund Type Spread of Credit Qualities Within Each Fund
(Click to enlarge)

When thinking about your risk level, it may be helpful to look not only at average credit quality, but also the spread of quality levels that result in the average quality level, as shown in Figure 4.


Figure 5: Bond Fund Type Composition by Type of Bonds

(Click to enlarge)

When thinking about your risk level, it may be helpful to look not only at average credit quality (and the spread of qualities), but also at the type of bond: government issued, corporate issued, securitized, municipal and synthetic (derivative).


The data in Figures 2-5 is from Morningstar Advisor Workstation.

Price Charts for Bond Fund Types
(click images to enlarge)

Here are the charts for each of the bond funds in the table above, listed in the same order as in the tables.  These charts were produced mid-day April 15, whereas the tables were produced as of end-of-day Friday April 10.

You can judge for yourself how useful the binary evaluation of slope and moving average stacking tells the story, and how well it assets you in keeping your eyes honest as you look at charts, and how using a simple set of binary decisions enables you to compare many charts, each of which may have more information that you remember.

Each chart shows the 1 year percentage total return (as calculated by in black, the 200-day exponential moving average in gold, the 50-day exponential moving average in dashed blue, and he ratio of the funds performance to the performance of BND (aggregate US bonds) in green in the lower panel.