The U.S. dollar has spent much of this year as one of the most disappointing major developed market currencies, but recent price action suggests the greenback could be shaking out of its malaise. Since the start of the fourth quarter, the U.S. Dollar Index is higher by 1.8%.
A rebounding dollar is likely to help currency hedged exchange traded funds, such as the Deutsche X-trackers MSCI EAFE Hedged Equity ETF (NYSEArca: DBEF). As the U.S. dollar strengthens, foreign currencies would depreciate. If an investor holds a foreign stock that is denominated in the local currencies, a weaker foreign currency would translate to a lower USD-denominated return on that foreign equity exposure.
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 Fed tightening and loose policies overseas, should consider currency-hedged ETF strategies to limit the currency risks.
DBEF is already showing its positive correlation to the stronger dollar. The ETF is up more than 6% in the fourth quarter after hitting a record high on Wednesday, a move that pushed the fund’s year-to-date gain to over 15%. DBEF tracks the MSCI EAFE US Dollar Hedged Index.
“The index is designed to provide exposure to equity securities in developed international stock 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 21 countries: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom,” according to Deutsche Asset Management.
Related: Why Consider a Currency Hedged Strategy with International ETF Exposure
The $7 billion DBEF holds 942 stocks. Foreign exchange currency fluctuations are a significant driver of international investment risks, but it is one factor that investors can get a handle on. According to Deutsche Asset Management, from 1973 through 2016, leaving in currency exposure to an MSCI EAFE investment resulted in volatility on average 2.7 percentage points higher 91% of the time.
DBEF allocates almost 21% of its weight to financial services stocks with the industrial and consumer discretionary sectors combining for over 26% of the fund’s weight.
Japan and the U.K. combine for almost 42% of DBEF’s geographic exposure with France and Germany combining for another 20%.
For more information on the currency hedging strategy, visit our currency-hedged ETFs category.