The U.S. dollar has recently gained some momentum, a factor that can be unnerving for some investors considering emerging markets equities. Investors can stick with emerging markets stocks in a strong dollar environment with currency hedged exchange traded funds, including the X-trackers MSCI Emerging Markets Hedged Equity ETF (NYSEArca: DBEM).
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.
The widely followed MSCI Emerging Markets Index entered Thursday with a slight year-to-date loss, much of which was attributable to recent dollar strength. However, DBEM is sporting a modest year-to-date gain thanks to its currency hedge. DBEM tracks the MSCI EM US Dollar Hedged Index.
Currency-Hedged ETF Strategies
The fund’s underlying index “is designed to provide exposure to equity securities in the global emerging markets, while at the same time mitigating exposure to fluctuations between the value of the U.S. dollar and non-U.S. currencies. As of December 31, 2014, the Index included securities from the following 23 countries: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, South Korea, Malaysia, Mexico, Peru, Philippines, Poland, Russia, Qatar, South Africa, Taiwan, Thailand, Turkey, and United Arab Emirates,” according to DWS.
DBEM holds nearly 850 stocks. 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 Fed tightening and loose policies overseas, should consider currency-hedged ETF strategies to limit the currency risks.
The currency-hedged international investment strategy is not a short-term play but a strategic long-term view for portfolio construction when incorporating international market exposure, which just so happens to be a good opportunity right now as many foreign markets look attractive relative to the pricey valuations on domestic equities.
China, South Korea and Taiwan combine for over 54% of DBEM’s geographic exposure. Overall, emerging Asian economies represent over 72% of the fund’s weight.
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