Decline in Brazil’s Real Underscores Need for Currency Hedging

Emerging markets will be challenged in a post-coronavirus environment even harder than during the crisis, which could put pressure on their currencies via a sustained flight to the safe haven U.S. dollar. Brazil is contending with this challenge as it’s real has been seeing fresh lows, which underscores the need for currency hedging strategies in this uncertain market environment.

Per a Nasdaq report, the “real BRL= fell about 0.9%. Its sharp decline since the coronavirus outbreak, which has seen it underperforming its peers, has prompted sustained intervention by the Brazilian central bank to stop further weakness.” Additionally, Brazilian president Jair Bolsonaro is facing public backlash for his handling of the coronavirus pandemic.

While global stimulus packages are helping to prop up economies in developed markets, this will be a challenging endeavor to take on for more cash-strapped EM countries. As such, more volatility could be ahead for EM assets, such as currency.

“We see risks skewed towards a renewed increase in EM FX volatility as the economic shock on EM economies intensifies and risks of further waves of virus cases increases,” wrote Mitul Kotecha, senior emerging markets strategist at TD Securities. “Unlike developed economies, the capacity for EM governments and central banks to deal with the economic and health shock is lower.”

Because investing in EM equities can rely heavily on how well its currency is performing, it’s important for investors to use hedging techniques to protect against sharp market downturns. EM currency investors saw that play out well during the height of the coronavirus sell-off in the equities markets.

Given that, what’s one way to hedge?

EM Currency Hedging Built Into One ETF

While investors can utilize a plethora of currency hedging techniques, one way to do so without overcomplicating the process is via currency-hedged exchange-traded funds (ETFs). One fund is that hedges against EM countries like Brazil is the Xtrackers MSCI Emerging Markets Hedged Equity ETF (DBEM).

DBEM seeks investment results that correspond generally to the performance of the MSCI EM US Dollar Hedged Index. The fund, using a “passive” or indexing investment approach, seeks investment results that correspond generally to the performance, before fees and expenses, of the underlying index, which is designed to track emerging market performance while mitigating exposure to fluctuations between the value of the U.S. dollar and the currencies of the countries included in the underlying index. It will invest at least 80% of its total assets in component securities of the underlying index.

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