If you invested in a sterling hedged version of a Japan fund a couple of years ago, you are probably feeling very pleased with yourself. Since January 2013, it has been far better to be hedged than unhedged in Japan.
A currency hedge aims to take the foreign currency return out of the equation. Without hedging, an investor’s return will be the foreign portfolio return plus the foreign currency return. For sterling investors in Japan, to be unhedged or hedged is an important decision, as currency can have a huge impact on returns.
In 2011 as the yen strengthened it was better to be unhedged. In January 2013, we advised investors to hedge their Japan exposure using two then relatively new Japan exchange traded funds (ETFs) that had sterling hedged share classes: iShares MSCI Japan Monthly GBP Hedged (IJPH) and db X-trackers MSCI Japan GBP Hedged TRN Index ETF (XMJG). The Japanese yen went on to depreciate markedly against other major currencies, including sterling.
Below is a performance comparison of the hedged and unhedged versions of Japan ETFs, plus a comparison of IC Top 100 Fund GLG Japan CoreAlpha's hedged and unhedged versions. As you can see, you would have done significantly better in 2013 if you held the hedged versions and this trend has continued into 2014. The hedged versions are more expensive in terms of their ongoing charge but the outperformance has more than compensated for this.
Total returns from hedged and unhedged Japan funds
| JAPAN FUNDS | 2013% | 2014* % | Ongoing charge % |
| HEDGED VERSIONS | |||
| iShares MSCI Japan GBP Hedged UCITS ETF (IJPH) | 53 | 6.2 | 0.64 |
| db X-trackers MSCI Japan Index UCITS ETF (DR) GBP Hedged (XMJG) | 53.8 | 5.8 | 0.6 |
| GLG Japan Core Alpha Equity D H GBP (IE00B665M716) | 59.8 | 1.1 | 1.88 |
| UNHEDGED VERSIONS | |||
| iShares MSCI Japan UCITS ETF Acc GBP (CSJP) | 24.9 | 2.8 | 0.48 |
| db x-trackers MSCI Japan Index UCITS ETF (DR) 1C GBP (XMJP) | 24.6 | 2.9 | 0.5 |
| GLG Japan Core Alpha Retail Acc (GB00B0119933) | 31.5 | -1 | 1.71 |
Source: Morningstar. Note: *To 31 October 2014
This week, Tilney Bestinvest is advising that investors in Japan funds stick to currency hedged versions of Japan funds. The investment advice firm believes the recent massive reallocation in favour of domestic equities by the Japanese Government Pension Investment Fund, plus lower energy prices should provide a boost to Japanese equities and industry.
However, the Bank of Japan aims to expand its annual monetary expansion target from Yen 60-70 trillion to Yen 80 trillion as it moves towards doubling the country’s monetary base. This could put further pressure on the currency. Jason Hollands, managing director, business development and communications with Tilney Bestinvest says: "It's difficult to know whether the yen has now reached its floor level, but with the printing press on full blast, currency risk is something UK-based investors might want to neutralise when investing in Japan."
Other funds that have sterling hedged share classes include JO Hambro CM Japan GBP A Hdg (IE00B5LD7P60) and Schroder Tokyo Z GBP Hedged (GB00B8BJDX53).
Exposure to the foreign currency can work both ways and many investment advisers say that over the long term fluctuations in currency will even out.
Alan Steel, the founder of independent advice firm ' Steel Asset Management, says: "We tend to leave it to the investment managers to decide these things, and even they tell us hedging or not hedging currencies is their most difficult decision usually. So if the professionals worry about making mistakes in this, it's best for ordinary investors to keep out of the way. What I would say is when a question like this is popular, which it is, it's usually too late."
