Critical Currency Consideration

“Since 1973, the U.S. dollar cycle has ranged from six to 10 years, excluding current cycle,” Sean Edkins, Director and ETF RVP for Deutsche Asset & Wealth Management, said. “The current cycle of U.S. dollar strength likely began in 2011 during the European sovereign debt crisis.”

Edkins also explains that currency moves have contributed to a significant portion of international equity return and provided a persistent source of volatility. For instance, looking ahead, Edkins calculated as the EUR falls to $1.05 by the end of the year, the potential currency impact could result in a 5.9% decline in an unhedged investment. By 2017, Deutsche predicts the EUR to fall to $0.85, which could translate to a 23.9% negative impact on an unhedged investment.

With a stronger dollar and lower foreign currency outlook, investors seeking international market exposure may do well with a currency-hedged ETF strategy. [4 Things To Know About Currency Hedging]

For instance, John Nance, Director of Operations at Sterling Global Strategies, pointed out that the Deutsche X-trackers MSCI EAFE Hedged Equity ETF (NYSEArca: DBEF), a popular way for investors to diversify into international developed Europe, Australasia and Far East, or EAFE countries, has provided a better risk-adjusted return than unhedged EAFE ETFs in the current dollar bull market. [The Rise of Currency-Hedged ETFs]

“Our findings show the DBEF product outperformed the unhedged product by 38 bps while nearly cutting the standard deviation of the returns in half,” Nance said.

DBEF and other currency-hedged ETFs follow factor-based or smart-beta indices. Anil Rao, V.P. of Index Applied Research at MSCI Inc., explains that MSCI Hedged Indexes reflect the equity performance of an MSCI equity benchmark and removes the currency effect.

“The indexes aim to measure the impact on performance of hedging the currency exposure of MSCI international equity indexes against an investor’s base currency using a monthly currency Forward contract rollover,” Rao said.

Financial advisors who are interested in learning more about smart-beta, currency-hedged index strategies can listen to the webcast here on demand.