Investors can use a hedged-equity exchange traded fund to capture foreign growth opportunities while mitigating currency risks as other developed countries implement their own quantitative easing programs to stimulate their economies.
On the recent webcast, The Importance of Currency Hedging in a Strong Dollar Environment, Carl Noble, Senior Investment Analyst for Pinnacle Advisory Group, points out that liquidity through quantitative easing has been a powerful driver of growth, fueling the rally in the U.S. equities market over the past five years.
Consequently, Noble contends that similar monetary policy changes could also support a growth opportunity in other overseas markets where central banks have been cutting rates and raising quantitative easing, such as the European Central Bank and Bank of Japan.
Rod Smyth, Chief Investment Strategist at Riverfront Investment Group, and Chris Konstantinos, Director of International Portfolio Management for Riverfront Investment Group, both agree that QE in the other developed markets could help their respective economies.
ECB president Mario Draghi has stated on Thursday that they will not enact a bond purchasing program until next year. Smyth argues that the Eurozone will need to add quantitative easing program to get itself out of the ditch. Konstantinos added that the ECB is currently failing miserably with its inflation mandate, which leaves the central bank with a lot of room for further policy changes. [Time is Right for Currency Hedged ETFs]
Nevertheless, once the QE kicks in, the Riverfront strategists believe the added liquidity will translate to improved growth in earnings.
“Best earnings recovers are in US and Japan, where central banks have engaged in widespread quantitative easing,” according to the Riverfront strategists.
While an investor can capture growth in overseas developed markets through an Europe, Australasia and Far East ETF, one will be exposed to currency risks. According to a recent ETF Trends and RIA Database survey, the majority financial advisors expressed concern over European currency weakness.
A weaker foreign currency means that the assets would generate a lower U.S.-dollar-denominated return. Currently, the U.S. dollar is shifting toward a strengthening cycle.
“The dollar has been in a secular decline for more than a decade,” Luke Oliver, head of U.S. ETF Capital Markets at Deutsche Asset & Wealth Management, said. “With the average USD cycle at about eight years and the USD near all-time lows, that tide could shift at any time…. With QE, the dollar has been kept low, but will likely begin to gain more strength and momentum as QE begins to taper.”
Investors who are interested in capturing developed Japan and European markets but are wary also about depreciating foreign currencies can take a look at a hedged EAFE ETF, such as the DeutscheX-trackers MSCI EAFE Hedged Equity Fund (NYSEArca: DBEF). DBEF includes country exposures to Japan 22.4%, U.K. 18.5%, Switzerland 9.7%, France 9.5%, Germany 9.1%, Australia 7.4%, Netherlands 4%, Spain 3.5% and Sweden 3%.
The currency hedge difference has been on full display this year as DBEF has jumped 5% while the unhedged MSCI EAFE Index is lower by 4.7%. That scenario helps explain DBEF’s exponential growth. DBEF entered 2014 with about $313 million in assets under management. Today, the ETF has over $1.2 billion in assets under management. [Falling Currencies Lift This ETF]
Financial advisors who are interested in learning more about a currency-edged developed market strategy can listen to the webcast here on demand.