As exchange traded fund investors think about diversifying their portfolios with foreign exposure, there are some specific considerations to keep in mind, specifically currency risk.

When investing in overseas assets, investors will typically have to hedge against changes in foreign-exchange rates, writes Chana R. Schoenberger for the Wall Street Journal.

In a non-hedged foreign investment, you will see your returns fluctuate based on how the U.S. dollar moves against currencies represented in your portfolio.

Schoenberger points out several factors to look out for when taking on foreign investments.

  • An appreciating foreign currency translates to greater per share returns. Stock or bond ETFs that hold foreign currency denominated securities will see a slightly higher return when the foreign local currency appreciates against the U.S. dollar. The stronger foreign currency means the investment provides investors with more U.S. dollars if you sell it.
  • There is no definite measure to how much currency fluctuations affect fund returns. “Funds do not have to report how much of their performance is due to currency effects, and we can’t actually tell,” Gregg Wolper, a senior fund analyst at research firm Morningstar Inc., said in the article.
  • Over the past decade, currency trends have bolstered overseas investment returns. The U.S. dollar has weakened against most foreign currencies for the past 10 years, especially over the past few years after the Fed’s quantitative easing program inundated the market with U.S. currency. But this is subject to change as the Fed cuts back on accommodative measures.
  • Most international-stock funds don’t hedge against currency movements. “They buy stocks with foreign currency and just keep that foreign exposure,” Wolper added. However, there are a few currency-hedged equity ETFs available, notably from WisdomTree and Deutsche Bank.
  • Good examples where currency hedging would have helped investors over the past year are in the Indian rupee and Japanese yen – the U.S. dollar appreciated 29% against the rupee and 17% against the yen since the end of 2008. While there are no India hedged-equity ETFs available, yen-hedged Japan ETFs have outperformed the non-hedged version over the past year. [Japan ETFs: Down, but not Out]
  • The New Zealand has been the best foreign currency to hold unhedged against the U.S. dollar since 2008, according to Ravi Bharadwaj, a senior market analyst at the Western Union Business Solutions unit of Western Union Co. The iShares MSCI New Zealand Capped ETF (NYSEArca: ENZL) jumped 12.6% last year. [New Zealand ETF at Crossroads as Rate Hikes Loom]

For more information on global investments, visit our global ETFs category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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