As investors look to overseas equities and international ETFs to access these markets, one should consider the consequences of currency fluctuations and ways to hedge these foreign exchange risks.

Among many factors, the strong dollar is again dragging on emerging markets equities this year. However, there are avenues for investors looking to take some of the bite out of that situation. Consider the FlexShares Currency Hedged Morningstar EM Factor Tilt Index Fund (NYSEArca: TLEH).

TLEH tries to reflect the performance of the Morningstar Emerging Markets Factor Tilt Hedged Index, which tries to enhance exposure to developing markets by tilting toward the long-term growth potential of small-cap and value segments while hedging against currency risks.

TLEH includes one-month currency forwards contracts to diminish the potential volatility in currencies with respect to the U.S. dollar – if foreign currencies depreciate against the greenback, international equities may generate a lower USD-denominated return. However, potential investors should be aware that if the foreign currencies appreciate against the USD, currency-hedged ETFs may underperform non-hedged funds.

Time For TLEH

As ETF investors seek international exposure to diversify their equity portfolio and potentially tap into more attractive plays abroad, traders should consider currency-hedged strategies that allow investors to capture upside potential in the global markets while hedging against potentially weakening international currencies or a stronger U.S. dollar.

Consequently, investors who are worried about the risks associated with wide currency swings in their international equity exposure, especially in the upcoming period of diverging monetary policies among global central banks, or loose policies overseas, should consider currency-hedged ETF strategies to limit the currency risks.

The respective currencies of emerging markets are already feeling the ill effects of the coronavirus pandemic, but that’s not all. Like the rest of the world, many companies are facing default on their debt and emerging markets aren’t precluded from that same dilemma.

TLEH essentially acts like a hedged version of FlexShares’ popular emerging market fund, the FlexShares Morningstar Emerging Markets Factor Tilt Index Fund (NYSEArca: TLTE). The ETF includes a 100% position in TLTE but counteracts currency risks with currency forwards that correspond with its country weights, including Hong Kong, South Korea, Taiwan, India, South Africa, Brazil, Mexico, Malaysia, Thailand and Russia.

For more on multi-asset strategies, please visit our Multi-Asset Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.