International currency moves will impact investors’ foreign equity allocations, but investors can turn to currency-hedged exchange traded fund strategies to mitigate the foreign exchange risks and provide a purer play on the underlying overseas markets.
In the upcoming webcast, A Strategy to Thrive in a Strong U.S. Dollar Environment, Jason Chen, senior research analyst at DWS Research Institute, DWS, underscored the impact of currencies on volatility. Currency fluctuations have a significant impact on portfolio volatility. In general, hedged international indices have had lower volatility than unhedged indices. While unhedged investors have benefited from higher returns over some periods, they have also experienced higher volatility in most cases.
On the other hand, hedged investments can offer smoother long-term investments. For instance, Chen pointed out that hedging currency risk has, on average, reduced volatility by 1.7% in the EAFE. Moreover, the max drawdown has been worse for the unhedged EAFE in 16 of 21 calendar years, compared to a currency-hedged EAFE.
“Historically, hedging out the currency risk has led to lower volatility and less drawdown in a diversified portfolio,” Chen said.
To help investors access a range of currency-hedged international markets, DWS offers a suite of currency-hedged ETFs, including:
- Xtrackers MSCI All World ex U.S. Hedged Equity ETF (DBAW)
- Xtrackers MSCI EAFE Hedged Equity ETF (DBEF)
- Xtrackers MSCI Emerging Markets Hedged Equity ETF (DBEM)
- Xtrackers MSCI Europe Hedged Equity ETF (DBEU)
- Xtrackers MSCI Eurozone Hedged Equity ETF (DBEZ)
- Xtrackers MSCI Germany Hedged Equity ETF (DBGR)
- Xtrackers MSCI Japan Hedged Equity ETF (DBJP)
Craig Columbus, CEO of Columbus Macro, also helped outline the currency moves in the foreign exchange markets. He noted that long-term U.S. dollar mean reversion is not guaranteed and may occur outside your investment horizon. Long-run currency moves are often unforecastable and can lead to errors in capital market assumptions. On the other hand, the cleanest way to capture relative country valuation premium is to hedge currency effects. For instance, the hedged EAFE exposure can provide portfolio diversification benefits. Additionally, Columbus argued that a mix of hedged and unhedged holdings can yield optimal results.
Columbus pointed out that the Japanese yen currency recently touched a 24-year low against the U.S. dollar due to a divergence between Federal Reserve hawkishness and the Bank of Japan’s ultra-loose, yield curve control. The recent global inflationary pressure has presented Japan with a once-in-a-lifetime opportunity to end deflation.
Meanwhile, Columbus added that the euro currency recently hit a two-decade low against the USD. The ECB also recently raised rates for the first time in more than a decade, with consensus expectation tightening cycle to end at around 1.5% in 2023.
As we witness the changes in the foreign currency markets, Columbus highlighted the potential impact on international investor portfolios. Specifically, currency movements impacted 10-year MSCI EAFE returns for U.S. investors. The currency-hedged index outperformed local currency (positive hedge return). Additionally, the standard deviation was also lower for the hedged index. Columbus concluded that for U.S. investors, unhedged currency exposure has tended to increase the volatility of international equities.
Brian Wright, chief investment officer at Columbus Macro, explained that at Columbus Macro, they have also utilized ETFs, like the Deutsche X-trackers MSCI EAFE High Dividend Yield Equity ETF (NYSEArca: HDEF) and the Xtrackers MSCI All World ex-U.S. High Dividend Yield Equity ETF (NYSEArca: HDAW), to diversify international exposure. HDEF and HDAW do not hedge their currency exposure. The MSCI EAFE High Dividend Yield offers a compelling yield relative to its historical norm and also offers a compelling valuation compared to other global indices. The strategy provides exposure to international value stocks with a tilt toward quality/profitability.
Financial advisors who are interested in learning more about currency-hedged investment strategies can watch the webcast here on demand.