As the rally in U.S. equities grows long in the tooth, many are looking to international markets to find opportunities. Looking at the various options available, investors may want to consider a currency-hedged exchange traded option to gain overseas exposure.
For instance, the IQ 50 Percent Hedged FTSE International ETF (NYSEArca: HFXI) and IQ 50 Percent Hedged FTSE Europe ETF (NYSEArca: HFXE) are two options that have been outperforming. Year-to-date, HFXI gained 6.7% and HFXE rose 6.2%. In contrast, the S&P 500 was up 5.3% so far this year.
With the 50% currency-hedged ETFs, “you don’t have to make a currency call (fully hedged/unhedged) and are getting international exposure,” Salvatore Bruno, IndexIQ Executive VP & Chief Investment Officer, told ETF Trends.
When gaining overseas exposure, foreign exchange fluctuations are among the largest contributors of portfolio volatility. Consequently, as more investors and advisors look to foreign market exposure to diversify, many are considering the currency risks that come with it.
Looking ahead, the Federal Reserve is embarking on interest rate normalization, has hiked rates for the second time in almost a decade and signaled it may raise rates two more times, which may diminish the supply of greenback and help strengthen the U.S. dollar against foreign currencies. Additionally, President Donald Trump has indicated that he will enact business-friendly policies to help strengthen the U.S. economy, which will also further strengthen the dollar.
On the other hand, foreign central banks are still implementing loose monetary policies, with some even targeting even looser policies, potentially weakening their currencies even further against the greenback.
If investors gain exposure to these foreign markets, investors will be exposed to these weakening foreign currencies and the negative effect once converted back to U.S. dollar-denominated returns on the international investments.
However, the Forex market is notoriously fickle, and the U.S. dollar has actually been weakening since the start of the year. Consequently, investors who have a more neutral stance on the foreign exchange outlook may consider a 50% hedged international investment, like HFXI and HFXE, as a way to limit volatility in their international exposure due to a sudden currency swing.
“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,” Adam Patti, IndexIQ chief executive officer, said in a note.
Specifically, unlike more popular currency indexes available that hedge 100% of the US dollar currency exposure of the underlying securities, HFXI and HFXE’s underlying indices from FTSE Russell hedges against 50% of the fluctuations between the US dollar and the home currency of the underlying index constituents.
The IQ 50 Percent Hedged FTSE International ETF tracks the FTSE Developed ex North America 50% Hedged to USD Index, which is made up primarily of large- and mid-cap companies in Europe, Australasia and the Far East. Top equity holdings in HFXI include Nestle 1.7%, Samsung Electronics 1.4% and Roche Holding 1.3%.
HFXI devotes a large 23.6% to Japan and 16.6% to the U.K., along with 41.3% to other Developed European countries. Top sector weights include financial 20.8%, industrials 13.2% and consumer cyclical 12.0%.
The IQ 50 Percent Hedged FTSE Europe ETF is benchmarked to the FTSE Developed Europe 50% Hedged to USD Index, which is made up of equities from 17 developed European countries. HFXE also features Nestle 2.9%, Roche Holdings 2.1% and Novartis 2.1%.
The U.K. holds a dominant position in HFXE, commanding a 28.3% weight. Top sector weights include financial 20.5%, consumer defensive 13.9% and healthcare 13.0%.