ETF Trends
ETF Trends

As investors begin to utilize exchange traded funds to diversify away from domestic markets, more are beginning to understand how currency risk can affect equity portfolios.

On the recent webcast, Have You Hedged Your Clients’ Japanese Equity Exposure?, Raman Aylur Subramanian, Managing Director & Head of Index Applied Research for the Americas at MSCI, warned advisors about factors to look out for when investing overseas.

“Increased allocation to foreign equities in U.S. portfolios, leads to a higher exposure to foreign currencies,” Subramanian said.

Consequently, advisors should begin thinking about how to they can hedge their equity positions when investing in overseas markets like Japan, the third largest global economy.

“Hedging can prove vital in managing currency exposure especially if an investor has a bearish view on a currency,” Subramanian said.

The U.S. dollar is beginning to strengthen against other major currencies, and an appreciating dollar would correspond with weakening foreign currencies. Consequently, even if foreign currency-denominated stocks were rising, the increase in the foreign equity positions could translate to lower dollar-denominated returns.

“Time for the dollar to again be the strongest G10 currency for only the 6th time since the fall of Bretton Woods,” Daniel Brehon, FX Strategist at Deutsche Bank, said on the webcast.

A currency hedging strategy could have helped investors generate a higher return than a non-hedged equity position in Japan.

“The MSCI Japan Index, expressed in U.S. dollars, earned annualized returns of 7.53% from March 2013 to March 2014,” Subramnian added. ” If currency exposure were hedged, the index would have returned 17.11%.”

With a Japan hedged-equity ETF, like db X-trackers MSCI Japan Hedged Equity Fund (NYSEArca: DBJP), which tracks the MSCI Japan US Dollar Hedged Index, investors can gain exposure to the Japanese equities market without the currency risk. DBJP includes monthly currency forwards to hedge against a depreciating Japanese yen. [Rising Inflation Could Bolster Japan ETFs]

The ETF includes heavy exposure to industrials and consumer discretionary sectors that are more export oriented and benefit from a weaker Japanese yen. [Promise of a Pension Infusion Bolstering Japan ETFs]

For more information on Japan, visit our Japan category.

Financial advisors who are interested in learning more about hedging currency risk with Japanese equity exposure can now view the webcast on demand.