Global Investing with Hedged Exchange Rate Risk

By Brian Dolan, Head Market Strategist

  The sharp rise in the value of the USD relative to other major currencies since mid-2014 has had a major impact on investment returns for global investors.  Depending on the investor’s particular situation, their returns could have been positively or negatively affected. USD-based investors experienced added performance returns from global investments as the greenback strengthened. Non-USD based investors saw returns diminished as their home currencies weakened relative to the USD.

Going Global

It’s natural for investors looking to diversify their portfolios or pursue global investment themes to look to international investing options.  But international investments typically carry exchange rate risk (currency risk)—the risk that the currency in which the investment is denominated may decline in value relative to your home currency.

For example, if a US dollar-based investor invests in an ETF  (exchange traded fund) of European stocks (denominated in euros (EUR)), the investment is subject to currency risk. That’s on top of normal market risk (the risk that a market may decline).  If the EUR weakens relative to the USD (the buck strengthens), the investment may lose value in US dollar terms, even if the ETF investment showed gains in euro-terms.

Invest Abroad Regardless of the Greenback

The ever-expanding universe of ETFs offers a solution to this problem. There are a number of currency-hedged ETFs offering international investments that seek to eliminate currency risk. The most common currency- or FX-hedged ETFs are aimed at insulating against changes in the value of the US dollar. For USD-based investors, the returns on an international ETF will be based primarily on the performance of the underlying index.

Currency-hedged ETFs allow investors to pursue global investing strategies without worrying about what’s happening to currency values. If a USD-based investor believes that Japanese stocks are likely to perform well in the future, due to Bank of Japan policies for example, they can invest in Japanese stocks with a currency-hedged ETF.  Investors’ returns will be based on the performance of the Japanese stock index, largely independent of how the JPY fluctuates against the USD.

Currency-hedged ETFs are available for both main asset classes: stocks and bonds. In stocks, currency-hedged ETFs cover individual countries and major economic regions, such as the Eurozone or EAFE (Europe, Australasia, and Far East). For bonds, currency-hedged ETFs cover high-grade debt, typically government bonds, of major developed economies excluding the US.