Are You Protected from SGD Appreciation?
Key Takeaways
The appreciation of SGD can create a strange situation where you have relatively increased buying power, while also likely experiencing a decrease in your portfolio returns.
As an investor, accessing opportunities around the world is important. With unhedged foreign investments, when your home currency appreciates, it results in a negative impact on returns; conversely, when it depreciates, the impact is positive.
For investments with higher volatility like equities, currency impact is muted. However, in lower volatility instruments like bonds or foreign currency deposits, the negative impact is felt more keenly. This relates to many retirement or income-generating portfolios. Are your portfolios poised to handle these fluctuations?
Recent worries about global trade have resulted in the MAS slowing the rate of appreciation of the SGD.
Despite this move, the SGD is still relatively strong, having appreciated 3.4% versus the USD this year alone. There can be many reasons for the differential in the strength of various currencies, which are primarily determined by individual countries’ central banks and economic policies. The decline of the USD is likely caused by investor fear over the new Trump administration tariff policy and its resultant effects on the world’s largest economy.
Due to the lack of SGD investment options as well as the need to access a broad investment opportunity set globally, many local investors may be holding various different currencies in their investments. With unhedged foreign investments, when our home currency appreciates, it results in a negative impact on returns; conversely, when it depreciates, the impact is positive.
The negative impact of local SGD appreciation is felt more keenly when your investments are in lower volatility instruments like foreign currency deposits, structured deposits, and foreign currency bonds. For investments which have similar or higher volatility to currency, like equities, then the impact is not so pronounced.
The chart below shows the returns of equities and fixed income (both hedged and unhedged). As you can see in Fig. 1, there is not a significant difference for equity returns with very similar volatility. For bond returns in Fig. 2, hedged returns are very much smoother.
As a result, for investors with high allocations to stocks, hedging currencies does not meaningfully reduce return volatility. In contrast, for investors with high fixed-income allocations, currency hedging is an effective way to reduce portfolio volatility.
Should I Hedge or Not?
For portfolios which are in our local SGD currency but have underlying global exposures, we need to remove possible forex movements to smoothen out volatility and reduce variations; especially for portfolios which have higher exposures to fixed income.
The chart below shows that the standard deviation (or volatility) of portfolios which have a larger proportion of bonds is significantly higher than a similarly hedged portfolio. In addition, the dispersion between the minimum and maximum returns is very wide for unhedged portfolios.
As such, investors who are focused on income generation and have a large allocation to bonds and safer instruments in their investment portfolio must be mindful that currency effects do not lead to a negative outcome over time. Do not focus purely on the headline yield numbers and consider your total return (including currency effects) as well.
For instance, the graph below shows a USD Corporate Bond (BNP Paribas) priced at USD$100 par value in May 2022. A local investor would need to pay approximately S$138 for this bond due to the USDSGD exchange rate.
As this bond approaches its maturity date in Sep 2025 this year, it trades near its USD$100 par value. But for the SGD investor, he/she is sitting on a -5% loss as the bond is currently trading around S$130 due to the exchange rate. In addition, the income received is lower as well as the coupons are paid in the base USD currency.
Is the USD Going The Way of £?
Another worry on investors’ minds is whether the US dollar is still a viable currency to hold, given the US’s likely tumultuous path forward given the policy uncertainty. We can take a simple reference from history — the pound sterling was the primary reserve currency of much of the world in the 1800s and first half of the 1900s. However, by the 1960s the dollar had surpassed the pound to become the dominant currency.
When will the USD cease to be of significance? It is likely related to how long the US remains the superpower of the world. The chart below shows how the various superpowers of the world have risen and fallen over the years. Will China be the next superpower and will the RMB become the next reserve currency?
It is certainly possible.
In the case of the decline of the pound, this research note pointed out that given that the reserve currency tends to be very entrenched in the global monetary system, it will take a long while to retire and swap to a new one, like how it took the pound nearly 30 years to be replaced by the USD following the rise of the US after WWII.
It is hard to predict how currencies can move. But as we have seen, barely twenty years ago, the SGD was $1.7 to USD $1, as compared to now. As such, we should be mindful of how we allocate to foreign currency investments as the forex movements can have negative effects, especially for investments that are meant to be more conservative.
For our core portfolios in SGD, the fixed income exposure is by and large hedged back to SGD to negate foreign currency movements. For equity exposures, our preference is to avoid hedging due to its cost, which we have determined as not worth its price for, at least at this point in time.
Currency hedging is among the many aspects to consider when building globally diversified investment portfolios. A well-thought-out approach backed by academic research can help us help you better achieve your investment goals over the long term.
