Emerging markets stocks and the related exchange traded funds are getting drubbed this year. Strength in the U.S. dollar is widely cited as one of the reasons emerging markets assets are slumping, a scenario that highlights the utility of currency hedged funds.

Investors who are concerned about the continued strength in the U.S. dollar and its effect on emerging market exposure can also consider the iShares Currency Hedged MSCI Emerging Markets ETF (NYSEArca: HEEM) and the Deutsche X-trackers MSCI Emerging Markets Hedged Equity Fund (NYSEArca: DBEM).

HEEM, which holds the iShares MSCI Emerging Markets ETF (NYSEArca: EEM) with a currency hedged overlay, entered Friday with a year-to-date loss of just under 3%, significantly less bad than that of the unhedged MSCI Emerging Markets Index.

“For U.S. investors, if the dollar gets stronger, that exchange rate translates into lower returns for the international holdings,” said BlackRock. “If the dollar gets weaker, the opposite occurs, boosting returns. Given that the U.S. dollar on a trade-weighted basis is up more than 5% year-to-date against a basket of developed and emerging markets currencies, the currency move has impacted portfolios.”

Weighing On Performance

As this year’s price action confirms, investing in emerging markets assets without a currency hedge can be a risky proposition.

“For emerging markets, large currency moves this year detracted from the performance of international indexes, a sharp contrast to the persistent rally in 2017 amidst a backdrop of little volatility,” according to BlackRock. “The Federal Reserve’s interest rate hikes in the U.S. have contributed to the tightening of global financial conditions. This, coupled with rising trade tensions have influenced a broad unloading of emerging market currencies.”

The strong dollar, political volatility in Brazil, trade wars with China and chaos in Turkey are among the factors punishing emerging markets assets this year.

“In short, investors looking abroad need to consider the impact of currencies in the international portion of their investment portfolios across both stocks and bonds,” according to BlackRock.

For more information on the developing economies, visit our emerging markets category.

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.