A fully hedged portfolio historically diminished returns when the U.S. dollar weakened or international currencies appreciated – since a hedged portfolio shorts foreign currencies, investors would miss out on the added boost from stronger international currencies. On the other hand, an unhedged strategy historically underperformed when the USD appreciated or foreign currencies weakened – if international currencies depreciate, foreign currency-denominated investments would have a lower USD-denominated return.
Alternatively, investors may consider a 50% hedged/50% unhedged option, including the IQ 50 Percent Hedged FTSE International ETF (NYSEArca: HFXI), IQ 50 Percent Hedged FTSE Europe ETF (NYSEArca: HFXE) and IQ 50 Percent Hedged FTSE Japan ETF (NYS Arca: HFXJ). All three funds have approximately half their currency exposure of the securities in the underlying index hedged against the U.S. dollar on a monthly basis.
“Our research has shown that a 50% currency hedged approach can not only reduce the potential risk of misreading extreme currency movements (in either direction), but can also have a dampening effect on volatility,” Patti added.
Furthermore, ETF investors may also consider some new dynamic or adaptive currency-hedged international stock ETFs that recently began trading. For instance, BlackRock’s iShares has come out with the iShares Adaptive Currency Hedged MSCI Japan ETF (BATS: DEWJ), iShares Adaptive Currency Hedged MSCI EAFE ETF (BATS: DEFA) and iShares Adaptive Currency Hedged MSCI Eurozone ETF (BATS: DEZU). The Adaptive Currency Hedged ETFs may shift from 0% unhedged currency exposure to 100% fully hedged, depending on differences in interest rates, relative valuations, currency momentum and currency volatility.
WisdomTree offers the WisdomTree Dynamic Currency Hedged Europe Equity Fund (BATS: DDEZ), WisdomTree Dynamic Currency Hedged Japan Equity Fund (BATS: DDJP), WisdomTree Dynamic Currency Hedged International Equity Fund (BATS: DDWM) and WisdomTree Dynamic Currency Hedged International SmallCap Equity Fund (BATS: DDLS). The four Dynamic Currency Hedged Equity Funds will hedge currency fluctuations in the relative value of the foreign currency against the USD, ranging from 0% to 100% hedge based on interest rate differentials, valuations and relative price momentum of the foreign currencies compared to the USD.
Max Chen contributed to this article.