Jeremy Schwartz - "You Should Be Hedged a Lot More Than You Are" | #26

Episode Summary

Executive Summary: Meb Faber and Jeremy Schwartz discuss practical factor investing across currencies, equities, bonds, and liquid alternatives. Schwartz argues investors should avoid uncompensated currency risk, use dynamic hedging when appropriate, recognize hidden factor exposures in low-vol and bond indexes, and focus on shareholder yield, buybacks, and global opportunities outside the U.S.

Main Topics: Currency hedging and dynamic FX strategies (Priority: 5/5): Schwartz argues currency risk is often misunderstood, not always expensive to hedge, and should usually be hedged or dynamically managed rather than left unhedged. He explains WisdomTree’s value, momentum, and carry-like signals for adjusting hedge ratios. Factor investing in equities (Priority: 5/5): The conversation covers WisdomTree’s dividend-weighted, earnings, and quality strategies, plus the role of low volatility, interest-rate sensitivity, and embedded exposures within factor portfolios. Factor exposure in bonds (Priority: 5/5): They discuss how bond indexes are market-value weighted toward issuers with the most debt, and how WisdomTree uses yield-tilted and fundamentals-based approaches to improve core and high-yield bond exposure. Managed futures and liquid alternatives (Priority: 4/5): Schwartz explains improvements to WisdomTree’s managed futures methodology, including multiple trend signals, position scaling, and volatility screening to improve robustness. Buybacks, dividends, and shareholder yield (Priority: 5/5): The pair argue that buybacks are underappreciated and should be combined with dividends when estimating long-term returns, especially in the U.S., where net buybacks materially affect growth. Global asset allocation and relative valuation (Priority: 4/5): Both speakers suggest U.S. investors are overallocated to domestic assets and should consider cheaper overseas markets, especially when relative to low real bond yields. Travel, tools, and practical investor habits (Priority: 2/5): The episode closes with practical app recommendations and a brief discussion of travel, VPNs, and using technology to access information efficiently while abroad.

Key Arguments: Currency hedging is often portrayed as costly, but Schwartz says the cost is highly regime-dependent and can even be positive for U.S. investors hedging euros or yen. Unhedged foreign equities add volatility without expected return; currency risk should generally be treated as uncompensated risk unless there is a deliberate tactical reason to take it. Dynamic currency hedging can improve outcomes by combining interest-rate differentials, momentum, and purchasing-power-parity/value signals. Factor portfolios can contain large unintended exposures, especially to interest rates; low-volatility strategies may behave like bond substitutes. Bond indexes are not neutral: market-cap weighting gives more weight to the most indebted issuers, which may be undesirable for investors seeking quality or yield efficiency. A simple yield-tilting approach in core bonds can improve income without major duration changes, while fundamental screening in high yield can improve quality. Buybacks are economically meaningful because they reduce shares outstanding and accelerate future per-share growth; dividends alone understate shareholder payout. Buybacks and dividends together form a better estimate of long-run expected real returns than dividends alone. The U.S. is more buyback-oriented than developed international markets, though Japan is increasingly emphasizing shareholder returns and governance. For long-term investors, overseas markets look cheaper than the U.S., and current U.S. bond yields make equities relatively more attractive than cash-like fixed income. Low-volatility, utilities, and other factor sleeves can be heavily influenced by rate cycles; investors should understand these embedded bets before using them as “defensive” holdings.

Data Points: WisdomTree assets: $40 billion or so - Meb introduces Jeremy Schwartz’s firm Currency hedging cost in Brazil: 14% interest rates - Schwartz cites Brazil as an example where hedging is expensive ECB interest rates: -40 basis points - Used to explain why hedging the euro can be profitable U.S. interest rates: +40 basis points - Compared with Europe to show hedge carry benefit Yen interest rates: -10 basis points - Used to explain why hedging yen can pay investors Average long-run currency hedge carry: almost 40 basis points per year - Schwartz says hedging foreign currency has been paid on average over 30 years MSCI EAFE stock volatility alone: 14.4 - Used in comparing stocks alone versus stocks plus currency MSCI EAFE stock plus currency volatility: 17 - Shows higher volatility when currency is left unhedged Incremental volatility from currency: about 260 basis points higher - Difference between EAFE stocks alone and with currency WisdomTree currency-hedged asset share in Europe and Japan: roughly 30% of assets hedged - Schwartz says many more assets should be hedged Australia Vanguard overseas assets hedged: about 50% - Example of international hedging behavior Initial WisdomTree ETF/fund landscape: 300 ETFs and $300 billion in assets - Meb notes the industry scale at the time of first launches Current ETF landscape: closer to $2 trillion and 5–6 times as many ETFs - Shows growth in the ETF industry since 2006 S&P 500 dividend yield: about 2% - Discussed in relation to buybacks and expected returns S&P 500 net buyback yield: about 2% - Used to argue shareholder return is understated if buybacks are ignored Nominal dividend growth historically: about 5% - Meb and Schwartz discuss conventional return decomposition Buyback-adjusted dividend growth expectation: about 7% - Schwartz argues buybacks should raise future per-share growth U.S. broad dividend index: 3% dividend yield and 1.8% net buyback yield - Example of combining dividends and buybacks in U.S. equities EFA broad developed international: 4% dividend yield and 28 bps buyback yield - Illustrates the U.S. versus international shareholder-yield comparison U.S. quality dividend growth: 3.5% net buyback yield - Example of a shareholder-yield-rich strategy U.S. earnings family: about 3% buyback yields - Used to show buyback intensity by strategy Yield-enhanced AG index improvement: 60–70 basis points higher yield - Claimed improvement from reweighting core bonds toward yield Tracking error constraint: 35 basis points per month - Constraint used in the yield-enhanced bond strategy July 8 rate bottoming date: July 8 - Used as a turning point for rates, financials, utilities, and low volatility Small cap earnings strategy: lower P/E, cyclical, less rate-sensitive - Highlighted as one of Schwartz’s preferred U.S. strategies Japanese financials move: down 40% through July 8, then up 20–25% since - Illustrates high bond/rate sensitivity and recovery after rates rose Managed futures enhancements: 3 trend signals over 3, 6, and 12 months - WisdomTree’s updated trend methodology Managed futures universe screen: remove highest-volatility commodities - A volatility filter to improve trend-follower robustness

Pivotal Quotes: "currency hedging is expensive. This is a broad conversation that a lot of people say. And the truth is, it's only selectively expensive." — Jeremy Schwartz: Explaining why currency-hedging myths mislead investors "you shouldn't be unhedged all the time." — Jeremy Schwartz: His core view on foreign equity currency exposure "the only thing they shouldn't be doing is being unhedged all the time." — Jeremy Schwartz: Reinforcing the case for strategic or dynamic hedging

Implications: Investors should rethink default assumptions about currencies, bonds, and buybacks. Active factor management can reduce hidden risks, improve return efficiency, and reveal that global equities outside the U.S. may offer better long-term value.