Remember currency hedging?
Back in the day (meaning, say, 2015), when the dollar was strong and risking, funds like the WisdomTree Japan Hedged Equity Fund (DXJ) were all any of us could talk about. Assets flooded into currency-hedged international equities. I remember I even spoke at various roadshows touting currency as the most important decision most advisors were ignoring.
And yet that conversation seems to have largely dissipated.
Some of this is just the inevitability of performance chasing. The U.S. Dollar Index peaked shortly after the election in 2016 at 103, and has slid as low as 88 just a few months ago. In that environment, currency-hedged international ETFs haven’t seemed like such a great deal.
And yet, over any meaningful time period, the bet still seems to have paid off. Check out the quick chart of emerging markets in dollar and local terms over the past five years.
And even since the dollar’s peak in December 2016, the decline and recent recovery of the dollar has made the two versions of emerging markets just about equal: up 28% in dollar terms, or 27% in local terms (and both well ahead of the roughly 20% rise in the S&P 500).
So what to do now? Unfortunately for investors, there’s no getting out of making this decision. You can ignore it, and simply invest in one of the large, popular ETFs covering individual countries or groups of countries. That decision is explicitly making the call to go short the dollar, and long the local currency.
Mathematically, if the dollar rises 1%, that’s 1% you’ll need to make in appreciation on your investment just to stay even. If you choose to invest in a hedged ETF, you’re now long the dollar and long the local investment, so the inverse is true—if the dollar goes down 1%, you’ll need to make that up in the local market.
As investors, we don’t get the privilege of not having an opinion. Every choice to invest outside the U.S. is an embedded call on the dollar versus the currency of our target investment. And this is a problem, because I honestly have no idea what the dollar is going to do for the next few months, much less the next few years. The dollar bulls point to the effect of tax cuts and a strong economy. The dollar bears point to the drag of huge deficits and global reactions to U.S. rate hikes.
So perhaps the best thing is to hedge your bets—in the truest sense of the word. Splitting your investments between hedged and unhedged variants (which is fairly easy to do thanks to ETF product proliferation) could at a minimum remove one source of uncertainty from your returns … unless, of course, you’re absolutely certain about the direction of the dollar. In which case, I’m guessing the Federal Reserve has a position open for you.