A few years ago, the term “currency war” became a global buzzword phrase. It was used to describe a situation where countries deliberately devalue their currency to gain a competitive economic advantage. Besides triggering retaliation from countries hurt by international trade, currency manipulation causes all kinds of chaos, including damage to investment returns.
Let’s examine how financial advisors can defend client portfolios against the disruptive forces of currency warfare.
Unmasking Performance Returns
Foreign investments in stocks and bonds aren’t just affected by local economic activity, interest rates, or earnings—but by currency values, too. While this doesn’t diminish the importance of securities diversification, gyrations in foreign exchange rates is an added dimension of financial risk. How can financial advisors mitigate these risks in client portfolios?
The first step is to recognize that performance returns on international investments—whether they be stocks or bonds—are significantly impacted by the direction of the currencies those assets are denominated in. (Our case study of Europe listed below will illustrate this point.) This means that advisors should consider currency-hedged positions when warranted.
Hedging tools such as currency futures, forwards, and options are available, but their complexity makes it difficult to implement a cost-effective hedging solution that clients can understand. On the other hand, currency-hedged ETFs, because of their reasonable fees and relative simplicity, offer a viable hedging alternative.
Here’s a quick snapshot of the top currency hedged equity ETF providers:
• Deutsche Bank offers 22 currency-hedged equity ETFs that charge annual expense ratios between 0.35 percent and 1.1 percent
• BlackRock’s iShares unit offers 26 currency-hedged ETFs that charge expenses of 0.23 percent up to 0.71 percent
• WisdomTree offers 30 currency-hedged ETFs that charge annual expenses between 0.43 percent and 0.58 percent.