Journal of Financial Planning: January 2014
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.
International equity exposure helps diversify portfolios away from home country bias, but many advisers are finding currency fluctuations adversely affect returns. Currency-hedged ETFs are a solution to that problem.
Martin Kremenstein, managing director at Deutsche Asset and Wealth Management, Jeremy Schwartz, director of research at WisdomTree, and I recently discussed how foreign currencies can effect your global equity portfolio.
“When you invest internationally, you end up taking two positions,” Kremenstein said. “You take a position in the international asset, and you’re taking a position in the currency.”
Advisers must take into account the targeted foreign market conditions and potential changes in the foreign exchange market. Generally, a foreign investment will benefit from an appreciating local currency, however, a weaker local currency means the foreign investment is worth fewer U.S. dollars.
A Look at Japan
Drastic shifts in Japanese monetary and fiscal policy have provided a good example of how currencies play a pivotal role in foreign equity returns. Shinzo Abe was elected prime minister in late 2012, winning on a platform of aggressive policies aimed to double inflation and depreciate the strong yen to bolster the economy. The Bank of Japan has since adopted an unlimited quantitative easing program and the government enacted a series of spending programs. Consequently, the U.S. dollar has gained almost 22 percent against the yen over the past year.
Looking at the non-currency hedged Japan, the iShares MSCI Japan ETF (EWJ) has gained an impressive 33 percent over the past year as the loose monetary and fiscal policies kicked in. Not bad.
Advisers can capitalize on growing overseas markets while mitigating the negative effects of a depreciating foreign currency through ETFs. The WisdomTree Japan Hedged Equity Fund (DXJ) and db-X MSCI Japan Currency-Hedged Equity Fund (DBJP) have outperformed EWJ, returning 50 percent and 61.3 percent over the past year, respectively. The currency-hedged ETFs are designed to generate higher returns than a non-currency-hedged investment as the yen weakens relative to the U.S. dollar. Comparing the two hedged equity funds, DXJ tilts toward exporters and DBJP takes a broader domestic approach to Japanese equities.
Options for European Equity Exposure
Investors can choose from a wide range of currency-hedged equity ETFs. Advisers wary about a depreciating euro can take on European equity exposure that hedges the euro with the WisdomTree Europe Hedged Equity Fund (HEDJ) or the db X-trackers MSCI Europe Hedged Equity Fund (DBEU). HEDJ has a larger weight in industrials and consumer discretionary stocks, whereas DBEU leans toward financials and consumer staples. DBEU takes on a 29.4 percent exposure to the U.K. while HEDJ excludes U.K. exposure.
Moreover, advisers can take on focused exposure to the U.K. through the db X-trackers MSCI United Kingdom Hedged Equity Fund (DBUK) and WisdomTree United Kingdom Hedged Equity Fund (DXPS), or to Germany through the db X-trackers MSCI Germany Hedged Equity Fund (DBGR) and WisdomTree Germany Hedged Equity Fund (DXGE).
Deutsche Bank’s db X-trackers also offers other broad market exposure.Advisers can take broad emerging market exposure through the db X-trackers MSCI Emerging Markets Hedged Equity Fund (DBEM), which includes Brazil and 20 more countries. If you are only interested in Brazil, the db X-trackers MSCI Brazil Hedged Equity Fund (DBBR) could fit your needs. The db X-trackers MSCI EAFE Hedged Equity Fund (DBEF) offers access to developed markets in many nations. A
recent addition is the db X-trackers MSCI AC Asia Pacific ex Japan Hedged Equity Fund (DBAP).
With ETFs, financial advisers who are interested in diversifying into overseas equities can take control of foreign currency risk. Investors don’t have to worry about the negativity associated with a weak currency. Instead, a currency-hedged equity ETF takes the Forex out of the equation and allows advisers to focus on foreign market returns.