More investors are looking to international markets and exchange traded funds as a way to diversify away from potentially overvalued U.S. equities. However, potential traders should keep in mind the risks associated with international investments, notably foreign exchange or forex risks.
ETF Trends publisher Tom Lydon spoke with Abby Woodham, ETF Strategist for Deutsche Asset Management, at the 2017 Morningstar Investment Conference in Chicago April 26-28 to talk how currencies influence an international equity position.
“It’s certainly something that’s come to the fore of investor’s mindset given the strength of what we’ve seen in the dollar,” Woodham said.
When exposed to international equities, investors should keep in mind the foreign exchange fluctuations between the U.S. dollar and foreign currencies. If foreign currencies weaken or the U.S. dollar strengthens, international equity returns are lower when converted back into USD-denominated returns.
“What a lot of investors don’t realize is that they actually have passive exposure to currencies if they’re not currency hedged – any investment that’s denominated in something other than dollars,” Woodham said. “So we typically talk about international stocks; what you really own… is two asset classes: the international stocks and the currency exposure.”
Investors would normally gain exposure to these international markets, and returns will be driven by the return of the various developed market stocks, along with the fluctuations of the various developed market currencies.
Alternatively, investors can turn to currency-hedged ETFs to limit forex risks. For example, the Deutsche X-trackers MSCI EAFE Hedged Equity ETF (NYSEArca: DBEF) tracks developed Europe, Australasia and Far East countries and hedges against depreciation in related currencies.
Investors can also track other various market segments in the international space while hedging against currency risks through currency-hedged ETF strategies. For instance, the Deutsche X-trackers MSCI All World ex US Hedged Equity ETF (NYSEArca: DBAW) provides broad market exposure by following a market cap-weighted index of international stocks, excluding U.S. exposure and hedging against depreciation in the underlying currencies against the U.S. dollar. Additionally, the Deutsche X-trackers MSCI Emerging Markets Hedged Equity Fund (NYSEArca: DBEM) targets the emerging markets.
ETF investors can also find more targeted exposure through specific options. For instance, Deutsche X-trackers MSCI Japan Hedged Equity ETF (NYSEArca: DBJP) and Deutsche X-trackers MSCI EMU Hedged Equity ETF (NYSEArca: DBEZ) provide targeted exposure to Japan and the Eurozone, respectively.