When investing in overseas markets, investors should consider a currency-hedged international stock exchange traded fund to help diminish volatility associated with foreign exchange risks.
“Since 1978, currencies have increased volatility 91% of the time over five-year rolling periods, contributing 2.7% more volatility on average each year,” Robert Bush, ETF Strategist at Deutsche Asset Management, said on the recent webcast, Currency – Hedging Matters: Simple ETF Strategies.
However, investors can take steps to manage the risks. Scott Kubie, Chief Investment Strategist at CLS Investments, pointed out that hedging currency exposure in international investments has historically lowered risks or volatility associated with fluctuating overseas currencies.
Investors should also note that currencies typically follow ebbs and flows. After years of depreciating against foreign currencies, the U.S. dollar is finally in a bullish cycle. Kize Behrends, ETF RVP at Deutsche Asset Management, pointed out that since 1973, the U.S. dollar cycle has averaged eight years and the current cycle of a stronger U.S. dollar began in 2011.
“While currencies are very challenging to predict on a shorter term basis, we have seen a trend in the U.S. dollar cycle since it became a free-floating currency in 1973,” Behrends said. “Historically, each U.S. dollar cycle, up or down, lasts around eight years, with downward cycles recording possible dollar depreciation up to 50 percentage points. Currently, we are in our fourth year of the current U.S. dollar bull cycle, up 29%, with what we believe is still some room for the U.S. dollar to appreciate.”
Consequently, if the U.S. dollar continues to strengthen, foreign currencies will depreciate, which would weigh on an investor’s overseas investments – a weaker foreign currency means that returns are lowered when converted back into USD terms.
While unhedged investors may still benefit from higher returns in some years as the foreign currencies appreciate, an unhedged position will exhibit greater volatility. Alternatively, Behrends argued that hedged investments can provide a smoother long-term investment with less drawdowns to worry about.
“In a traditional portfolio consisting of 30% international stocks, we contrasted allocating to hedged vs. unhedged strategies,” Behrends added. “Over the short term, we found a material difference in overall returns, which diminished over long time horizons. But by minimizing currency exposure with a hedged solution, standard deviation fell consistently over the past 15 years.”
ETF investors who are interested in a currency-hedged international position have a number of options available. For broad exposure, the Deutsche X-trackers MSCI All World ex US Hedged Equity ETF (NYSEArca: DBAW) follows a market cap-weighted index of international stocks, excluding U.S. exposure. The Deutsche X-trackers MSCI EAFE Hedged Equity ETF (NYSEArca: DBEF) tracks developed Europe, Australasia and Far East countries. Additionally, the Deutsche X-trackers MSCI Emerging Markets Hedged Equity Fund (NYSEArca: DBEM) targets the emerging markets.
Financial advisors who are interested in learning more about overseas investments and foreign currency risks can watch the webcast here on demand.[related_stories]