The U.S. dollar is on a tear – it hit an 11 year high against the euro in January and a seven and a half year high against the yen this past November, according to Bloomberg. This is great news if you travel outside the U.S. For example, if you went to Europe, your 4-euro cup of coffee costs you $4.50 versus $5.50 a year ago. (In that time, the exchange rate went from $1.37 per euro to $1.18).
If you’re an investor, the logic is similar. If you hold non-U.S. assets, the returns on your investments will be affected when you translate your investment from its local currency back into dollars. So, while most well-diversified portfolios should include investments in countries outside the U.S., you should also consider whether you need to attempt to cushion their currency impact.
We believe this dollar rally will have legs, as global economies – and consequently, monetary policy – continue to diverge. Both the Bank of Japan and the European Central Bank have been injecting stimulus in an effort to boost growth, even as the Federal Reserve begins turning off the spigot as the U.S. economy improves.
In other words, we think investors should expect the dollar to strengthen for some time longer – and prepare accordingly.
Targeting currency risk with hedged ETFs
The impact of currency movements on your investment portfolio depends on your local currency, of course. With the dollar appreciating, many U.S. investors will see the value of certain of their international holdings decline, at least in currency terms, as they translate their returns from a weaker euro or yen, for example, to a stronger dollar. It’s the opposite of getting that traveler’s discount on your coffee.
Adding a currency hedge to an international portfolio can help reduce this risk while still maintaining diversification benefits and exposure to potential growth opportunities outside the U.S. Exchange-traded funds (ETFs) offer a convenient, low-cost way to potentially hedge the currency risk of your international investments. Indeed, investor interest has been remarkably strong during this recent cycle: Over the past three months, more than $15 billion flowed into currency-hedged ETFs (Source: Bloomberg and iShares).
Currency hedging from a leading provider
Is hedging right for you? Currency volatility tends to smooth out over time, so it may not be necessary for your broad, long term building block positions. But if you take a more active view or hold more precise international exposures, then hedging through an ETF may be a sensible addition to your tactical investment strategy.
To position and potentially cushion your international holdings against currency risk, dollar-based investors can consider currency hedged versions of five iShares flagship international funds, including the iShares Currency Hedged MSCI EAFE ETF (HEFA), the iShares Currency Hedged MSCI EMU ETF (HEZU) and the iShares Currency Hedged MSCI Germany ETF (HEWG).
Daniel Gamba, CFA, is Managing Director and head of BlackRock’s iShares Americas Institutional Business. He is also a member of BlackRock’s Global Operating Committee. He is a regular contributor to The Blog and you can read more of his posts here.