When investing in international shares, is it better to have exposure to the dollar or invest in a hedged manner? – 03/14/2024 – From Grain to Grain

This week, I’m in New York at an event called Immersão Wall Street and organized by Samuel Ponsoni from Outliers Advisors. Every day we are visiting a management company and discussing international investment strategies, risk allocation and control processes and the managers’ and economists’ vision of the market.

Samuel has assembled an exceptional group of allocators for this event. 20 executives from the main institutions were selected. Modesty aside, our investment office is also part of this elite that brings together, among others, pension funds, multi and single family officesresource managers and investment advisory offices.

One of the discussions I had today with some group participants was about the best way to expose yourself to international investments.

In this article, I will only address investment in shares, but the decision may change slightly if the investment is in international fixed income and multimarket products.

You can have international equity exposure by investing directly in shares, or through BDRs, ETFs or investment funds.

There are some tax aspects that I will leave to discuss in the future.

I will focus on one of the discussions that was about whether it is better to invest in products hedged or with exchange rate exposure.

It is not possible to say which way is better, but it is important to understand the characteristics of each one to decide which one best suits your scenario.

The graph below shows the evolution of the three visions: return only of the S&P 500, S&P 500 with dollar effect and the S&P 500 hedged.

For us Brazilians, the most natural way would be to invest and have exchange exposure since our reference currency is the Real.

This approach brings the benefit of having exposure to the dollar as an element of diversification. Therefore, if there is a devaluation of the exchange rate, you can obtain additional returns from this source.

Also, in theory, the exchange rate would have the effect of smoothing sudden market movements. Normally, when crises occur and the stock market falls, the Real usually depreciates, that is, the dollar appreciates. As you are invested in dollars, you gain from this appreciation.

In the graph, it is possible to see that an investment of R$10 thousand, in 2000, in the S&P 500 would only have resulted in a value today of R$38.8 thousand (green line). When the exchange rate effect is added, that is, the appreciation of the dollar in the period, this return increases to R$98.7 thousand.

The other way to invest internationally is via products hedged. This term refers to the fact that the investment is protected against exchange rate fluctuations. Anyone who believes this is worse is mistaken. This way has some advantages.

When you do the hedge, that is, the exchange of one currency for another, the interest differential is gained, that is, the difference between the interest of the destination currency minus the interest of the origin currency. In this case, the destination currency is the Real, and the origin currency is the dollar.

As our interest rate is higher than the American one, this operation adds a positive result.

Over the years, it is possible to bring the average of this difference closer to around 50% of the CDI. Therefore, whoever invested in the S&P500 hedged, would have obtained an additional result of around 50% of the CDI. In several years, this difference was greater than 50% of the CDI, more recently, with the rise in American interest rates, it is less than this percentage.

Over the past 24 years, investing in the American stock index, the S&P 500, has hedgedin addition to having presented a higher return, it also presented lower volatility than the form with exchange rate exposure.

Since 2000, investing R$10,000 in the S&P 500 hedged would have resulted in a value today of R$ 141.9 thousand. Therefore, a result 44% greater than the traditional form of exposure with exchange rate variation.

As I mentioned, it is not possible to say that one way is always capable of producing greater results, as it depends on your expectation of future exchange rate variation and the interest differential between Brazil and the USA. However, it is also worth considering investments hedged in your international stock investment decision.

Michael Viriato is an investment advisor and founding partner of Investor’s House.

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