The global economy continues to strengthen and investors are taking notice, but when considering international exposure, it’s important to be mindful of foreign exchange fluctuations. Nevertheless, there are a number of currency-hedged global exchange traded funds to help mitigate the forex risks.
The European economy is steadily improving, supported by a wide range of indicators, which may lead to above average growth for the remainder of the year and into the next. Eurozone growth has accelerated, with growth and business indicators showing positive results.
The improved growth outlook has fueled speculation that the European Central Bank will begin to reduce its accommodative measures, which helped strengthen the euro currency against the U.S. dollar. However, the U.S. dollar has been on the weaker end of the foreign exchange market this year, but the U.S. economy continues to expand and the Federal Reserve is eyeing a tighter monetary policy.
“So volatility is not really dead, at least as it pertains to the currency markets – it’s just been keeping a low profile,” Salvatore J. Bruno, Chief Investment Officer and Managing Director at IndexIQ, said in a research note. “Based on the rumblings from the central banks, that could all change pretty quickly. On current pace, the era of negative and ultra-low interest rates appears to be drawing to a close in both the U.S. and the Eurozone. Exactly how markets will react is anyone’s guess at this point, but some kind of realignment is almost certainly in order. For international investors, currency moves may again play an outsize role in overall returns.”
International investors will have to juggle a number of factors when making their investment choices, putting into consideration the direction of interest rates, the pace of policy change and the movements of the dollar, euro, pound, yen and yuan, among others.
“From Brexit to the Bank of Japan, there are a multitude of pieces in motion,” Bruno added. “As central banks move towards ‘normalization,’ the level of volatility is likely to accelerate. Given the level of uncertainty, it makes sense for investors to consider hedging a little, with the goal of reducing exposure to any one currency or policy outcome.”
For instance, ETF investors may consider alternative options that take a more neutral view on foreign currency movements through a handful of 50% hedged/50% unhedged options, 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.
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The forex market is notoriously fickle, and the U.S. dollar has been depreciating 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 as a way to limit volatility in their international exposure due to a sudden currency swing.
IndexIQ research has shown that a 50% currency hedged approach can reduce the potential risk of misreading extreme currency movements in either direction and can also have a dampening effect on volatility, which may help investors capture any further upside potential while hedging against downside risks associated with harmful currency moves.