On the flip side, when the dollar rally has played out and investors sense a looming currency reversal, ETFs such as the PowerShares DB US Dollar Index Bearish Fund(UDN), CurrencyShares Euro Trust (FXE) and CurrencyShares Japanese Yen Trust (FXY) will come into vogue.
For most investors, an ETF which provides direct exposure to foreign markets, while avoiding currency risk, is a better option. The WisdomTree Europe Hedged Equity Fund (HEDJ) and the WisdomTree Japan Hedged Equity Fund (DXJ) are two examples. These funds lock in exchange rates through forward currency contracts, which brings an unusual benefit. If the dollar rallies further, as many strategists expect, then the currency contracts will tack on an extra dose of foreign exchange gains.
To be sure, an investment in Europe or Japan may not seem timely, as central bankers in Frankfurt and Tokyo work feverishly to stave off recessions. The WisdomTree funds side-step that concern by focusing squarely on exporters, many of whom will likely benefit from weaker currencies. The DXJ fund, for example, only owns Japanese companies that derive at least 20 percent of revenues from abroad. The HEDJ goes a step further, raising the minimum export threshold to 50 percent. The European fund carries a mid-range 0.58 percent expense ratio while the Japanese fund carries a 0.48 percent expense ratio.
Other currency-hedging ETFs include the iShares Currency Hedged MSCI Germany ETF (HEWG), Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF) and a half dozen other regional ETFs offered by these firms.
It’s overwhelmingly likely that central bank interest rate policies will diverge in 2015 as economic growth rates diverge, and adjusting for the impact of a strong dollar is a savvy hedge for your portfolio.