Currency hedging with overseas investments?

[tims]

Hi

I'm thinking about investing in a UK or European share fund while our dollar is reasonably strong but I'm having problems understanding currency hedging and whether to use it or not.
I thought currency hedging was meant to protect your investment if the dollar dropped but after reading some articles about hedging (below), I don't really get it.

For example at: http://www.peak.net.nz/index.php?page=currency
"Hedging 100% back to NZ dollars is often the preferred option for lower risk portfolios to reduce volatility. This strategy is not without risk though, as our currency could be massively devalued for example in (heaven forbid) an outbreak of foot and mouth disease. In that instance, unhedged overseas investments will protect some of the value of your KiwiSaver nest egg."

and:
http://http://martinhawes.com/recent-articles/ (article: Botulism: A timely reminder – 11 August 2013)
"Financial advisers and banks will also be able to help you buy offshore investment funds. However, you should be careful that the funds that they offer are not hedged back to the New Zealand dollar.
I have written previously about the hedging of international investments back to New Zealand dollars: currency hedging cancels out much of the reason for making international investments because you remain completely exposed to a major fall in the New Zealand dollar."

I would have thought that currency hedging would offer some sort of protection against a fall in the Kiwi dollar but the articles above suggest it doesn't.
I don't understand hedging; what are the advantages of currency hedging and when should I consider it when making overseas investments?

Thanks

Tim

[peat]

hey Tims
I think those explanations are both correct.


Outcomes :

Hedged - If the Kiwi goes up/down your investment o'seas is still worth the same in NZD (affected only by the changing of the quoted price of the fund - even though that quote is in foreign currency).

Un-hedged - If the Kiwis drops you o'verseas investment is worth more in NZD but if it gains your investment is worth less. Whatever gains/losses you make with the investment may be increased/decreased by the exchange rate.

Martin is right tho in my opinion you shouldn't hedge. If you do you are becoming a currency speculator and that is probably not your intention. However your post gives a view on the Kiwi and if you want to 'back that view' then you should hedge.
Also it costs to hedge.
AND consider that the investment likely has some hedging already in that the Kiwi tends to go up/down in conjunction with o'seas stockmarkets so if they both go down this effectively reduces the loss for you however somewhat at the cost that if they both go up this will reduce your gains. That correlation can of course change and the most likely cause of that happe4ning would be a foot and mouth attack here. Kiwi plummets , if you are unhedged your wealth is preserved.

One of the main goals of investing overseas is to diversify geographically and yet to hedge reduces that diversification bonus. Standard financial planning theory is that diversity is the only free lunch , i.e it costs nothing and improves results.

Hope this helps