Diversify Overseas while Hedging against Stronger Dollar

Journal of Financial Planning: January 2016


Tom Lydon is editor of ETFtrends.com and president of Global Trends Investments, a registered investment adviser. He is a frequent contributor to major print, radio, and television media.

After a multi-year rally in U.S. equities, investors, and financial advisers are looking to overseas markets to capture the next growth opportunity. As foreign central banks enact loose monetary policies to fuel their economies, and the U.S. Federal Reserve moves to normalize interest rates, currency risk will be a key concern in international exposure. Nevertheless, a growing number of international stock currency-hedged ETFs can help access global markets while mitigating foreign exchange risks.

The WisdomTree Europe Hedged Equity Fund (HEDJ) and the Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF) were two popular ETFs of 2015 through mid-November, attracting $15.7 billion and $12.8 billion in net inflows, respectively.

In a previous Journal column (“Protect Your Global Equity Allocation from Devaluating Currencies,” January 2014), I outlined up-and-coming WisdomTree and Deutsche Asset & Wealth Management currency-hedged ETFs that advisers could use to capture international growth and mitigate the negative effects of depreciating foreign currencies and introduced readers to focused, country-specific hedged ETFs. In the two years since, fund providers have jumped on the currency-hedged ETF theme.

BlackRock’s iShares has entered the field with currency-hedged ETF adaptations of a number of its country- and region-specific ETFs. For instance, the iShares Currency Hedged MSCI Japan ETF (HEWJ) holds the unhedged version (EWJ) but hedges against a depreciating yen through currency forward contracts, and the iShares Currency Hedged MSCI Eurozone ETF (HEZU) holds the iShares MSCI Eurozone ETF (EZU), along with euro currency forward contracts. Currency-hedged options to track equities markets are available in South Korea, Switzerland, Australia, Mexico, Italy, Spain, and Canada.

Interested in tapping into China’s mainland A-shares market but wary of a potential depreciation in the yuan currency? The recently released Deutsche X-trackers CSI 300 China A-Shares Hedged Equity ETF (ASHX) acts like the currency-hedged version of the popular Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR). CSOP Asset Management recently added the CSOP MSCI China A International Hedged ETF (CNHX).

Those concerned with heightened volatility could look to the suite of iShares currency-hedged low-volatility ETFs that cover Europe, emerging markets, developed EAFE countries, or the broader All-Country World Index.

Advisers who want to capitalize on global quantitative easing and the low interest rate environment could capture overseas easy money with currency-hedged real estate ETFs like the Deutsche X-trackers Dow Jones Hedged International Real Estate ETF (DBRE), or WisdomTree Global ex-U.S. Hedged Real Estate Fund (HDRW).

A fully hedged portfolio historically diminished returns when the U.S. dollar weakened or international currencies appreciated. A hedged portfolio shorts foreign currencies, so investors could miss out on the added boost from stronger international currencies. An unhedged strategy historically underperformed when the U.S. dollar appreciated or foreign currencies weakened.

This leaves more work for advisers when rebalancing a portfolio, and that may incur additional transaction fees and short-term capital gains. Alternatively, IndexIQ has come out with 50/50 currency-hedged ETFs, so advisers won’t have to bother monitoring two different positions. The 50 percent hedged, 50 percent unhedged ETF options include the IQ 50 Percent Hedged FTSE International ETF, IQ 50 Percent Hedged FTSE Europe ETF, and IQ 50 Percent Hedged FTSE Japan ETF.

WisdomTree and iShares have been working on “dynamic” currency-hedged ETFs that promise to adjust the percentage currency hedge on a measure of currency risk. The new funds will be a sort of smarter beta, currency-hedged ETFs play as the underlying indices may adjust their currency hedge based on prevailing currency market signals.

Investment Planning