Daniel Gamba highlights key implications for investors in a stronger dollar environment by taking a closer look at how iShares Currency Hedged ETFs can potentially help cushion the impact of currency risk.
The U.S. dollar is on a tear – it hit an 11 year high against the euro in January and a seven and a half year high against the yen this past November, according to Bloomberg. This is great news if you travel outside the U.S. For example, if you went to Europe, your 4-euro cup of coffee costs you $4.50 versus $5.50 a year ago. (In that time, the exchange rate went from $1.37 per euro to $1.18).
If you’re an investor, the logic is similar. If you hold non-U.S. assets, the returns on your investments will be affected when you translate your investment from its local currency back into dollars. So, while most well-diversified portfolios should include investments in countries outside the U.S., you should also consider whether you need to attempt to cushion their currency impact.
We believe this dollar rally will have legs, as global economies – and consequently, monetary policy – continue to diverge. Both the Bank of Japan and the European Central Bank have been injecting stimulus in an effort to boost growth, even as the Federal Reserve begins turning off the spigot as the U.S. economy improves.
In other words, we think investors should expect the dollar to strengthen for some time longer – and prepare accordingly.
Targeting currency risk with hedged ETFs
The impact of currency movements on your investment portfolio depends on your local currency, of course. With the dollar appreciating, many U.S. investors will see the value of certain of their international holdings decline, at least in currency terms, as they translate their returns from a weaker euro or yen, for example, to a stronger dollar. It’s the opposite of getting that traveler’s discount on your coffee.
Adding a currency hedge to an international portfolio can help reduce this risk while still maintaining diversification benefits and exposure to potential growth opportunities outside the U.S. Exchange-traded funds (ETFs) offer a convenient, low-cost way to potentially hedge the currency risk of your international investments. Indeed, investor interest has been remarkably strong during this recent cycle: Over the past three months, more than $15 billion flowed into currency-hedged ETFs (Source: Bloomberg and iShares).