Getting global diversification comes with its benefits by investing in international equities or bonds, but they don't come without their caveats. Investors can minimize the risk of global investing by implementing a currency hedging strategy.
A Money Management article noted how the paper To Hedge or Not to Hedge: A Framework for Currency Hedging Decisions in Global Equity & Fixed Income Portfolios did a deep dive into currency hedging strategies.
“For a global portfolio with a high equity allocation, hedging currencies tends not to reduce return volatility by a significant amount," the paper said. “Consequently, currency hedging decisions informed by forward currency premiums can increase expected returns without substantially increasing portfolio volatility.”
The report also highlighted the fact that a majority of the investments were in fixed income. Currency hedging, especially in this asset class, could be an ideal path to smoothening volatility.
“Therefore, completely hedging foreign exchange exposure may be appropriate for investors who prefer lower volatility from their global fixed income investments, while selectively hedged strategies can add value for those who are willing to accept more volatility in pursuit of higher expected returns,” the report said. “Investors should think through these implications in order to make an informed currency hedging decision consistent with their investment preferences and goals.”
Currency Hedging Built Into ETFs
An interesting all-world play that hedges against currency fluctuations against the U.S. dollar is the Xtrackers MSCI All World ex U.S. Hedged Equity ETF (DBAW). DBAW seeks investment results that correspond generally to the performance, of the MSCI ACWI ex USA US Dollar Hedged Index.
DBAW uses a “passive” or indexing investment approach, which is designed to track the performance of equity securities in developed and emerging stock markets while mitigating exposure to fluctuations between the value of the USD and the currencies of the countries included in the underlying index. It will invest at least 80% of its total assets in component securities of the underlying index.
Another option is the Xtrackers MSCI EAFE Hedged Equity ETF (DBEF), which seeks investment results that correspond generally to the performance, before fees and expenses, of the MSCI EAFE US Dollar Hedged Index. The fund seeks investment results that correspond generally to the performance of the underlying index, which is designed to track developed market performance while mitigating exposure to fluctuations between the value of the U.S. dollar and the currencies of the countries included in the underlying index. It will invest at least 80% of its total assets in component securities of the underlying index.
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