As the U.S. dollar continues its forward march, foreign currency exposure will be a significant risk for international exchange traded fund investors.
Rich Bernstein of Richard Bernstein Advisors argues that the U.S. dollar will continue to appreciate against a basket of foreign currencies due to deflation of the global credit bubble, reports Dimitra DeFotis for Barron’s.
“A strong dollar and disinflation/deflation seem more likely than inflation so long as global overcapacity forces nations to fight for market share and depreciate their currencies,” Bernstein said.
Many foreign central banks have cut rates or enacted other loose monetary measures to help stimulate their local economies and depreciate currencies in a beggar-thy-neighbor policy. For instance, Sweden, Denmark, India, Canada and Switzerland all shifted their monetary policies, following the ECB’s aggressive trillion-euro bond-purchasing plan. [USD ETF Advances in Ongoing Currency War]
Meanwhile, the U.S. dollar has been appreciating as speculators expect the Federal Reserve is more likely to hike rates, which would strengthen the dollar. Over the past year, the PowerShares DB U.S. Dollar Index Bullish Fund (NYSEArca: UUP) has increased 20.8% and the WisdomTree Bloomberg U.S. Dollar Bullish Fund (NYSEArca: USDU) gained 16.6%. [King Dollar ETFs Assert Their Royalty]
Consequently, now that the USD is on an upward trajectory, investors who want overseas exposure will have to consider currency risks.
“The recent rapid appreciation of the USD has significantly curtailed USD returns of non-US assets, and has made them somewhat less attractive relative to USD assets,” Bernstein added.
For instance, the Deutsche X-trackers MSCI All World ex US Hedged Equity ETF (NYSEArca: DBAW), which tracks international stocks outside the U.S. and hedges against depreciating foreign currencies, has increased 11.2% over the past year, whereas the iShares MSCI ACWI ex U.S. ETF (NasdaqGM: ACWX), which does not hedge its currency exposure, dipped 2.6% over the past year. [Currency-Hedged ETFs Better Reflect the International Markets]
Global bond ETF investors are also exposed to currency risks. For example, investors who access local-currency EM debt through the iShares Emerging Markets Local Currency Bond ETF (NYSEArca: LEMB) and Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) have generated negative total returns over the past year due to an appreciating USD. LEMB has declined 8.8% while EMLC decreased 10.0%.
Meanwhile, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) and PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY), which both track U.S.-dollar-denominated emerging market bonds, gained 5.4% and 6.8%, respectively.
For more information on investing in international markets, visit our global ETFs category.
Max Chen contributed to this article.