Table of Contents
- Need for High Exchange Rates and Currency Hedge Strategies
- Structural Differences Between Currency Hedge (H) and Currency Exposure (UH)
- Should We Switch Now? The Conclusion is “No”
- H Type Maintenance Strategy Until the Depreciation of the Currency
- Assumptions and Risks of the Strategy
- Conclusion: Maintain Currency Hedge Now, 1,200 Won Level is the Switch Timing
- Frequently Asked Questions (FAQ)
Need for High Exchange Rates and Currency Hedge Strategies
The current exchange rate of the Korean won to the dollar is around 1,470 won, and looking back at the trend over the past year, there have been clear signs of high exchange rates and a weakening won.
Over the last 90 days, USD/KRW has fluctuated between 1,378 won and 1,475 won, currently sitting close to the upper end. Considering that a few years ago the 1,200 won level was regarded as a period of won strength, the current exchange rate can be interpreted as overvalued.
Fluctuations in exchange rates significantly affect the economy as a whole, so attention to future trends is necessary.
In the current exchange rate environment, when selecting US equity pension products, it is essential to clearly analyze the impact of exchange rate fluctuations on future returns to determine whether the currency hedge (H) or currency exposure (UH) strategy is more appropriate. This analysis will enable more rational investment decisions.
Structural Differences Between Currency Hedge (H) and Currency Exposure (UH)
The KB Pension US S&P500 Index (H), one of the pension savings products, aims to reflect the dollar-denominated returns of the S&P500 index to the fullest extent. This product removes the impact of exchange rate fluctuations by utilizing currency derivatives. Therefore, it pursues a strategy that captures stock price returns while excluding currency gains or losses.
UH type reflects fluctuations in exchange rates directly in its returns.
When the exchange rate rises, the won weakens, benefiting the UH type. However, if the exchange rate falls, the won shows strength, leading to unfavorable conditions for the UH type.
Thus, it is natural that during the rapid surge in past exchange rates from the 1,200 won range to the 1,400 won range, the UH type's returns significantly exceeded those of the H type.
In the last three months, the UH type has achieved a return of about 11.36%, while the H type has recorded approximately 5.70%. The UH type, being a currency exposure type, has shown nearly double the excess return including currency gain in a high exchange rate environment. In contrast, the currency hedge H type reflects only the rise of the American index after removing the impact of exchange rate fluctuations. Currently, in a situation where the won is weak, the relative advantage of the UH type is becoming more evident.
Should We Switch Now? The Conclusion is “No”
The current exchange rate has reached 1,470 won, and switching to currency exposure (UH) at this point can be considered very risky.
This can be divided into two reasons. First, if the UH type is switched while the exchange rate is at a peak, a direct currency loss will occur if the exchange rate subsequently falls. In contrast, the currency hedge type is almost unaffected by declines in exchange rates, making it relatively resistant to losses in the current range.
Secondly, given that the exchange rate has already risen quite significantly, it is reasonable to assess that the risk of decline is greater than the possibility of further increases.
In conclusion, switching to the UH type now would pose a high risk of engaging in reverse trading by following the previous upward trend late. Thus, a cautious approach is necessary.
H Type Maintenance Strategy Until the Depreciation of the Currency
In a high exchange rate situation, it is appropriate to maintain the H type strategy. As the possibility of a strengthening won increases, selecting the UH type in this case could lead to large currency losses.
The strategy can be summarized as follows.
The first step is for the current exchange rate of 1,470 won to drop to around 1,300 won. At this point, we maintain the currency hedge type to safely navigate through the downward trend of the exchange rate.
The second step is when the exchange rate enters or gets close to the 1,200 won level. At this point, the strengthening of the won is assessed to be concluding, so it's necessary to consider switching to the UH type.
Finally, after switching to the UH type at the 1,200 won level, if the won weakens again and the exchange rate rises, the currency gains will have a positive impact on the returns of the UH type.
Ultimately, in a high exchange rate situation, selecting the H type, and in a low exchange rate situation, choosing the UH type is an effective timing strategy.
Assumptions and Risks of the Strategy
To execute this strategy, several important assumptions are necessary. First, there is no guarantee that the exchange rate will definitely fall to the 1,200 won level. For instance, there is a possibility that the exchange rate may rise above 1,470 won before declining. Fluctuations in exchange rate paths carry risks, and even experts find it difficult to predict the right timing.
Moreover, since pension or IRP are long-term investment products, considering a proper mix of the H type and UH type is also worthwhile. For example, a strategy can be set to fix 70% of US stock investment in the H type and adjust the remaining 30% to the UH type according to exchange rate fluctuations. This structural approach will help reduce volatility in the long term, mitigating risks associated with timing failures.
Conclusion: Maintain Currency Hedge Now, 1,200 Won Level is the Switch Timing
The current exchange rate is at a high level, and considering the potential for the won to appreciate in the future, maintaining the currency hedge type will be the safest strategy. It is reasonable to switch to the UH type as the exchange rate approaches the 1,200 won level.
What is crucial to note is not to change immediately, but to switch when the exchange rate has decreased.
Using such exchange rate-based strategies can effectively manage currency risks in long-term accounts such as pension savings or retirement pensions (IRP). The same principle applies to systematic investments in the S&P500 or Nasdaq, which will be beneficial in reducing volatility in returns over the long term.
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Frequently Asked Questions (FAQ)
Q. What is the current level of the won-dollar exchange rate and its recent trends?
The current won-dollar exchange rate is about 1,470 won, indicating a clear high exchange rate and won depreciation.
Over the past year, the won-dollar exchange rate has risen to about 1,470 won, and over the last 90 days, the exchange rate has fluctuated between 1,378 won and 1,475 won. Considering that the past 1,200 won range was seen as a strength period for the won, the current exchange rate is significantly overvalued. This high exchange rate environment greatly affects the economy as a whole, necessitating careful attention to future exchange rate trends.
Q. What are the differences between currency hedge (H) and currency exposure (UH) in US equity pension products?
Currency hedge removes the impact of exchange rate fluctuations, while currency exposure reflects exchange rate fluctuations in returns.
The currency hedge (H) utilizes currency derivatives to exclude the impact of exchange rate fluctuations, reflecting only the dollar returns of the US S&P500 index. In contrast, the currency exposure (UH) reflects exchange rate fluctuations directly in its returns, benefiting from exchange rate increases and incurring losses during decreases. Thus, in high exchange rate environments, the UH type is advantageous, while in case of currency depreciation, it can be unfavorable.
Q. Why is it risky to switch to currency exposure (UH) when the exchange rate reaches a peak?
Switching to UH at a high exchange rate poses a high risk of currency loss if rates fall.
With the current exchange rate around 1,470 won nearing its peak, switching to currency exposure (UH) could lead to direct currency losses if the exchange rate declines. On the other hand, the currency hedge type (H) is less affected by exchange rate declines, offering a higher level of loss resistance. Given that we are already in a high rate environment, the risk of decrease outweighs the likelihood of further increase, making late switches to the UH type a potential for reverse trading.
Q. What are the reasons and effects for maintaining the currency hedge (H) strategy in a high exchange rate situation?
Maintaining a currency hedge is a safe strategy to defend against exchange rate decline risks.
In a high exchange rate environment, there is a higher likelihood of a strengthening won, meaning that choosing currency exposure (UH) could expose one to significant currency loss risks. The currency hedge (H) is beneficial in securing stable returns by blocking losses from exchange rate fluctuations. Therefore, when the exchange rate is currently high, continuing with a currency hedge strategy reduces loss exposure and is effective for long-term investment.
Q. When is the optimal timing to switch between currency hedge and currency exposure in US pension investments?
Maintain currency hedge until the exchange rate falls to the 1,300 won range, consider switching to UH when it approaches 1,200 won.
Maintain the currency hedge (H) as the current high exchange rate of about 1,470 won waits for a safe reduction to around 1,300 won. After this, when the rate approaches or enters the 1,200 won range, assess that the strengthening of the won is concluding and consider switching to currency exposure (UH). This strategy aims to reduce exchange rate fluctuation risks while optimizing returns, making it suitable for long-term pension investments.
Q. What precautions and risks should we consider when executing investment strategies based on exchange rate fluctuations?
Predicting exchange rate paths is challenging, requiring appropriate diversification and structured approaches.
There is no guarantee the exchange rate will fall to the 1,200 won level; in fact, it might rise further from the peak before dropping, resulting in exchange rate fluctuation risks. Therefore, rather than relying solely on timing, it's recommended to appropriately mix currency hedge and currency exposure strategies. For instance, allocating 70% of US stock investments to currency hedge and 30% to currency exposure can help reduce volatility over the long term and mitigate risks of timing failures.