My colleagues and I, along with the rest of the market, watched as the U.S. dollar gained significant momentum last year. And the trend is continuing in 2015, with the dollar recently hitting an eleven year high against the Euro and a seven and a half year high against the Yen.1 This is especially good news for those of us who are looking to travel abroad this year. In fact, I’ll be booking my European vacation tickets shortly after finishing this Blog post.
If you’re not planning any big trips, but are invested in the market, you will likely feel the effects of a stronger dollar – especially if overseas interests are part of your well-diversified portfolio. Why? Quite simply, the difference in currency valuations can very well contribute to (or detract from) the overall return of the security itself. We like to think of it in the form of an equation:
Total Investor Return = Equity Return + Currency Return
Not only are your overseas investments affected by economic, political and market movement, they’re also impacted by currency fluctuations. So if you’re a U.S. investor like me, and you hold international ETFs, you may notice that a strong U.S. dollar can diminish your returns because those investments are held in the local currency. Many investors have already recognized this trend, as we’ve seen record flows into ETFs that are designed to hedge currency risk:
Source: Bloomberg & iShares Flows Data
We have seen inflows of $15.2 billion into currency-hedged ETFs over the last three months, $7.0 billion of which was in January alone.
How Long Will It Last?
That’s the $64,000 question, but key indicators tell us the trend is here to stay awhile. A key driver is the improving U.S. economy, with its strengthening monetary policy, better jobs numbers and surging domestic oil production, all of which support a stronger U.S. dollar. We’re seeing easing in the EU and Japan, which is impacting overseas currencies. My colleagues and I believe that we will continue this dollar strengthening phase, as historically we’ve seen such cycles last roughly six to eight years.
Considerations for Currency Hedged Investments