Fell asleep in Economics 101

I’m just having a brain fart here…
feels like the answer should be super obvious but I just can’t wrap my head around it :smiley:

Here’s the scenario

We are expecting the destabilisation of the dollar.

Investing in the S&P500, we are essentially taking a position in the dollar.
So we could invest in the S&P500 for example through:
a) Vanguard S&P500 ($) VUSD
b) Vanguard S&P500 (£) VUSD

-My original thought is that the right choice is (£) VUSD, since the invested pounds are now worth more dollars, ergo my investment goes up.

But for some reason I feel like I am missing something…

Which one is the right choice?

For a slightly different scenario

We are still expecting the dollar to devalue but we also don’t want to invest in a dollar based fund.

Let’s take iShares Physical Gold for example.
It is being offered in
a) iShares Physical Gold ($) IGLN
b) iShares Physical Gold (£) SGLN

-So here I would assume that the ($) IGLN would go up more. But since the fund isn’t based in the dollar, it doesn’t really matter which one you pick; you’re just keeping up with inflation.

But again, I don’t know if I am misunderstanding something.

@CaptainDangernoodle It makes no difference at all. This is because Trading 212 has no fee on currency conversion. So it will cost you the same in GBP to buy 1 share of either version. Subsequently that 1 share will always be worth the same in GBP. The dividends will also be worth the same in GBP. Taxes will be the same in GBP. If you think about it this makes sense. That one share of VUSA represently fractional holdings in all the constituents of the S&P 500. Your returns will depend on how their prices move. It is like saying that to walk from home to the postbox takes the same energy no matter if you measure it in meters or yards. Note that VUSA and VUSD are actually the same fund, with a single ISIN.

The reason that the two versions exist is to serve those investors who do not have access to fee free currency conversion between USD and GBP and so may find it less costly to deal in one or other currency.

The same is true for the two version of Physical Gold. If your base currency is GBP then it makes sense to choose that version. You can rest assured that you are not missing out on some benefit you might have obtained with the VUSD, or indeed with VUSA.DE (the euro denominated version).

I wrote about this once before.

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It is worth being aware that the greatest cost in buying VUSA is the double taxation of dividend income. Vanguard pays 15% US withholding tax on the dividends of those S&P 500 companies, deducts their 0.07% fee and pays what’s left to you as a fully taxable dividend, without the possibility of a tax credit for that 15% US tax paid. This is why the same basket of shares held personally, - if that were possible -, would pay you a dividend yield about 0.35% greater, (VOO [which is available to US investors with no withholding tax take] yields 1.98%, VUSA yields 1.71%, 1.99-1.71+0.07 = 0.35).

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When (if) you sell your return will be calculated relative to the conversion rate, at that time.

So when the £ moves stronger against the the $, that diminishes your return.

No. no. no. The exchange rate cannot have any effect on your investment return. Same as your tiredness in walking from point A to point B cannot depend on whether you measure in meters or yards.

If you do not believe me I challenge you to buy 100 shares of each in the practice account, wait a week or so and then sell them. You will see that your return will be identical, and not be affected by any change in the GBP/USD rate over the period of holding.

Maybe true in economical theory, if you were to continuously buy and sell the same shares.

But many of us have holdings where our perceived return fluctuates every day, and affects our Portfolio P/L

If I am misunderstanding, then T212 should really fix that.

If the only set of actions I were to ever make on the stock market were…

BUY $100 of Share A , at 1.28, which equals around £78

SELL Share A at the same price, with the rate now being 1.30,

The $ is now worth less, and gets converted to around £77, thus a £1 loss?

If I’ve misunderstood that, then please help me understand.

That is correct you have a loss due to depreciation of the USD against GBP.

But that is not what this thread is about. This thread has been discussing whether or not there can be different investment returns through purchasing VUSD (denominated in USD) or VUSA (denominated in GBP). The answer is that both VUSD and VUSA will give an investor the same profit or loss.

Suppose the dollar depreciates while the S&P 500 index remains flat. The price of VUSD will stay flat. The price of VUSA will go down and 100 shares of VUSA will be equal to the value to 100 shares of VUSD shares once those are sold and the proceeds converted to GBP. Either way the investor winds up with the same number of GBP.

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I understand the theory (I think) but I cannot make sense of the charts

When I look at the price change on the 3 month chart for both of them, we can see a percentage difference

And it is confusing because the pound increase (3.615) does not equate to the dollar increase (6.820)

For some reason VUSD has had a better growth.
I’ve noticed this difference with other ETFs too, like the Cloud Computing one everyone was talking about.

But maybe I am misunderstanding something fundamental here.

:slight_smile:

I think you need to take into account the conversion rate (£ vs $) on the date you purchase the shares, not only the date you sell them.

Let’s use your data: VUSA vs VUSD. In 3 months, VUSA increased 8.23% whereas VUSD increased 12.49%. Today, the rate is £1 = $1.29 which gives you £3.615 = $4.68. I checked the rate 3 months ago, £1 = $1.25 on April 29th. Let’s use these data.

Assume you spent £1 for VUSA and £1 for VUSD three month ago.

VUSA increased 8.23% so today you would have £1 * 108.23% = £1.0823.

On the other hand, to buy VUSD, you had to convert your money to $ on April 29. Because £1 was $1.25, you could get $1.25 of VUSD. After 3 motnhs, it increased 12.49% thus you would have $1.25 * 112.49% = $1.406125. Finally you convert it back to GBP. Thus, using today’s rate (£1 = $1.29), 1.406125 / 1.29 = £1.09.

Indeed, there was £0.01 difference here, but I assume it’s an error from the conversion rate I got. Basically, both VUSA and VUSD brought you the same amount of profit.

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@CaptainDangernoodle From the data in the two charts you show us we can deduce that GBP appreciated against USD by a factor of 1.1249/1.0823 = 1.03936 over these 3 months, which on referral to xe charts we can see is correct. (The chart below shows 1.0404, but the difference from 1.0394 is due to the start and end days not being exactly the same)

The pound increase is £3.615 = 0.0823 x, where x in the initial GBP price.

The dollar increase is $6.820 = 0.1249 y, where y is the initial USD price.

Thus y/x = 1.2431 must have been the exchange rate at the start and 1.2921 at the end.

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@Richard.W Ahhh so I WAS misunderstanding something fundamental after all. Thank you to you both for this detailed explanation.

I now figured out the initial error in my thought process which was quite silly too

When I said investing in the S&P500 is taking a position in the dollar I was thinking in the literal sense. Taking Vanguard again as an example, I assumed that the original fund share price is in dollars, and when you choose to buy the pound version, you are doing so through the dollar. In which case I would be speculating with forex. That there was my brain fart moment :stuck_out_tongue:

I understand that I am actually buying the fund, not the fund’s value in dollars. facepalm

Just needed some sleep
Thanks gents

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You are not entirely wrong. Buying a basket of US shares, which is what VUSA is, does involve speculation on the USD.

However, my view is that people worry too much about this currency loss. Suppose you buy VUSA and the S&P 500 index stays flat. But pound appreciates and so price of VUSA declines. You now have less pounds. But those pounds will go farther when you spend them on things you desire, especially commodites priced in dollars, investment in Apple and Microsoft stock, and things like foreign holidays. So sure, your quantity of pounds is less, but the pounds you have left are more valuable pounds.

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@CaptainDangernoodle, there is a way around this issue with the exchange rate. You can invest in currency-hedged ETFs to avoid speculating on the future exchange rate.

GBP-Hedged ETFs, as I understand it, periodically hedge the currency to avoid variations in the exchange rate affecting performance. ie. You get the return of the Index without considering changes in the exchange rate with the othe currencies, in this case the Dollar.

This is good if you think that in the long term the Pound will appreciate (strengthen) against the other currency eg. Dollar or Euro. On the other hand, if you think it will depreciate (weaken) buying the un-hedged (normal) ETF is better as an appreciation of the dollar will give you more pounds.

My plan is** to go 75% hedged ETFs (avoiding currency exchange variations) and 25% unhedged (normal) on USA ETFs, as I already have some other un-hedged World and Value ETFs as well as US stocks which will get exposure to the Dollar directly. So overall only around 30% of my USA exposure would be hedged.

Also to note: Hedged ETFs tend to have slightly higher OCFs than their unhedged equivalents.

If you are interested in GBP-Hedged ETFs to reduce exposure to the exchange rate on the pound, particularly now that it is quite weak due to Covid-19 and Brexit, I requested some in this post. They have not been added yet, so please support them if you are interested in them being added :slight_smile::

**Note: The plan is not currently in place as there aren’t any GBP-Hedged ETFs currently.

In my view currency-hedged ETFs make sense only if

(1) you think you are better able to forecast the movement of the GBP/USD exchange rate than everyone else in the world who is using these currencies, or

(2) you have an upcoming bill to pay and it is crucial that you do not suffer a loss if the others currency were to suddenly have a big decline relative to the currency in which that bill must be paid, and that would put your ability to pay at risk.

Personally, I have no confidence in my ability as regards to (1). My life experience has taught me that attempting to have good hunches about the exchange rate is a fool’s game. If you really think you have a good hunch that the pound will strengthen against the dollar then you may as well make a fortune by trading fx directly. Otherwise, why pay the higher OCF of a currency hedged ETF, which “on average” will lose you money compared to the unhedged version?

In my case, I do actually think that the GBP is quite weak currently and it will probably appreciate in the medium term. Nonetheless I agree with you that I would not trust my “foreign exchange intuition”, I think that would just be a bit of a gamble with my current very limited knowledge and understanding.

The main reason why I would like to invest a portion in hedged ETFs is that it simply reduces risk. Reducing risk also reduces potential reward, as always, but that is a price I am willing to somewhat accept by reducing my dollar exposure by around 30% (using 30% hedged ETFs). I wouldn’t want to limit it completely in case the dollar appreciates and also to keep my costs low.
Also, I do hold some shares so I would not able to remove the currency risk completely without betting against the dollar using alternative financial products that I am not keen on getting into. That is also one of the good thing of hedged ETFs, they are simple and I understand that any counterparty risk is low.

Also, the fees of some of them are very competitive so actually it doesn’t always cost much more. Some of the hedged ETFs can be quite expensive though, with OCFs over 0.5%, but there are also “cheaper” ones available. Some “low fee” ones to consider:

XTrackers S&P 500 UCITS ETF 2C GBP Hedged, ISIN: IE00BM67HX07, Bloomberg Ticker: XDPG:LN, OCF(%): 0.094
iShares Core MSCI EMU UCITS ETF (GBP Hedged), ISIN: IE00BG0J9Y53, Bloomberg Ticker: CEUG:LN, OCF (%): 0.12

These OCFs around 0.1% are similar to the unhedged versions.

The un-hedged iShares Core MSCI EMU UCITS ETF has the same OCF of 0.12%, and the Vanguard S&P 500 UCITS ETF which is also unhedged and is amongst the cheapest ETFs has an OCF of 0.07%.

Regardless of whether I’m right or wrong, I am just trying to understand the principle, so in the example I KNOW the dollar is going to lose value, thus I want to understand which one will grow more, the dollar denominated stock or the pound denominated stock.

It seems the answer is the dollar denominated stock will rise more.

Yes that’s a pragmatic viewpoint, but I wasn’t going that far. Only to the point of which maximises the currency gain.
Since you could choose to not spend your dollars that you cashed out until it recovers, for example.
:slight_smile:

Tl;dr
The answer to my original question, although not as important as I thought, is to buy the dollar denominated one if we think the dollar will devalue.

It makes no difference whatsoever if you invest £1000 in VUSA or VUSD. At the point you sell you will obtain the same number of £s - no matter which way the dollar moves against the pound.

Try this simple experiment. Buy £1000-worth of shares of each of VUSA and VUSD in the practice invest account, wait a week or so and then sell them. You will see that your return will be identical, and not be the least affected by any change in the GBP/USD rate over the period of holding.

It does not matter, the end result is the same. If your account is in GBP your return will be the same (in GBP) whether you buy the ETF in GBP or USD.

Edit: Just seen Richard’s reply. I completely agree with him on this :smiley:.

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