In the past month, non-U.S. developed markets equity ETFs
attracted $11.2 billion. During the same period, broad-based
developed markets equity added $3.7 billion, and Japanese equity
exposures attracted $4 billion. We believe this trend will
continue, and recently upgraded our view of Europe and Japan from
neutral to overweight, as noted in BlackRock's latest
As U.S. investors allocate more overseas for exposure to
potential enhanced returns and reduced risk through
diversification, many of them are unaware of how currency can
impact the overall return of any international equity investment.
In fact, currency can often contribute more to your return than
the underlying security itself. You can think of it as simply
Total Investor Return = Equity Return + Currency
Your total return depends on both equity and currency returns,
which are sensitive to economic, political, and market events,
and fluctuate over time. Below is an illustration of the
historical effects of currency fluctuation, comparing the MSCI
EAFE USD and the MSCI EAFE Local Index. As you can see, currency
values can drastically impact total return. For example, the
effect of currency in 2003 added 18% to an investment in the MSCI
EAFE Index for U.S. investors. This was a time when the U.S.
dollar weakened relative to other currencies, in particular the
euro and the yen, and an unhedged investment paid off.
Another example is in 2005, where the effect of currency took
15% from an investment in the MSCI EAFE Index for U.S. investors.
This was a time when the U.S. dollar strengthened relative to
other currencies, and marked a year where hedged investment paid
Think of it this way: if you have a positive view of the
underlying market equities in a foreign country, and a weak view
of the U.S. dollar (i.e. appreciating local currency), you could
select an unhedged currency investment, which most international
equity ETFs currently offer. On the other hand, if you have a
positive view of underlying market equities in a foreign country,
and a strong view of the U.S. dollar (i.e. depreciating local
currency), you could select a currency hedged product.
When the U.S. dollar appreciates, gains on international
equity investments can diminish when converted back into U.S.
dollars. This is especially relevant right now, as
expect the dollar to strengthen this year
. In a stronger U.S. dollar environment, hedged investments tend
to outperform. Investors seeking pure exposure to underlying
international markets can help to neutralize currency risk with a
currency hedged investment or ETF. Here are three things to keep
The effects of currency fluctuations are more relevant
today than ever before.
Investors are beginning to allocate a greater proportion of their
overall portfolios to international developed and emerging
markets to avoid home country bias, or over-investing in one's
own country. As Russ Koesterich points out in
, investors often exaggerate the benefit of physical proximity
and thus have overly-concentrated portfolios. Awareness of
this bias has increased recently and combined with attractive
fundamentals in markets outside the US- a reallocation outside
the US is clearly underway.
Currency hedged investments historically have exhibited
less volatility than unhedged.
What's more, hedged products are now large, liquid and accessible
to the average investor, offering international exposures while
reducing the risk of currency fluctuations. Three new solutions
include the iShares Currency Hedged MSCI Japan ETF (
), the iShares Currency Hedged MSCI EAFE ETF (
), and the iShares Currency Hedged MSCI Germany ETF (
3. Investors are beginning to take note of the
value of currency hedged ETFs.
In fact, currency hedged ETF flows hit a record $19.35 billion in
Most U.S. investors remain underexposed to international
equities, yet most strategists agree that bigger opportunities
exist outside U.S. borders. A couple of years ago, investors
didn't have the option of a hedged investment in ETFs. Today,
they have more control to ensure that the product you select more
accurately reflects your viewpoint. When investing in non-U.S.
equities, consider both equity and currency return, and where
currency hedging may suit you the best.