Quelling Eurozone Blues

October 26, 2011

European markets have been plagued by bad news and volatility for months. Luckily, ETF investors have tools with which to protect themselves.

The past few weeks, for the most part, have been generally positive for Europe. Shares rose on German and French assurances that they would increase aid to Greece. But the sell-offs are never far behind amid the threat of strikes in Greece and the apparent elusiveness of a definitive agreement.

Given the uncertainty and volatility, many people are simply steering clear of Europe and focusing on U.S. equities.

But for optimists who are ready to move back into international equities, a few defensive ETFs out there that temper risks by hedging the underlying currency exposure are worth considering.

For the most part, the underlying securities and currencies they are denominated in have tended to move in the same direction.

The graph of the iShares MSCI EMU Index (NYSEArca: EZU), plotted against the euro-dollar exchange rate, clearly shows this. EZU focuses on companies in eurozone countries.

 

Euro vs Europe performance

 

When an economy tanks, its currency tends to tank alongside it. Thus, failing to hedge your currency exposure could magnify losses on bad days, though it could also extend gains on good days.

As you can see in our FX Impact chart, currency exposures can affect returns in a big way.

Currency moves were a bit muted last week, but the prior week ending Oct. 14 was another story.

Investors in the MSCI Australia Index earned 1.06 percent over the week in the un-hedged fund, or 5.91 percent if they hedged their exposure to the Australian dollar. Similarly, investors in Norway earned 7.21 percent if they didn’t hedge their currency exposure, or 11.48 percent if they did.

 

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