DBGR, Get Specific With Your Currency Hedges

May 11, 2015

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article features Ron Saba, senior managing director of Investment Management at Charlotte, North Carolina-based Horizon Investments LLC.

 

The strengthening of the dollar against a number of currencies looks likely to continue in the coming months, and with it the protection U.S. investors have been getting by owning any number of internationally focused equities and even fixed-income ETFs with currency hedges.

 

Much of this is about divergent central bank policies. The Federal Reserve and the Bank of England are pretty much done with their quantitative easing programs, while the Bank of Japan and the European Central Bank are still in the middle of theirs. A total of 21 different global central banks are in the process of cutting interest rates (e.g., India, China) or devaluing their currency.

 

The implications for asset prices on these varying central bank policies are many. Central banks can affect foreign exchange rates, interest rates, risk premia, equity valuations—you name it. 

 

Let’s begin by knowing where we are today, and recognizing that going forward, more specific ETFs that target, say, specific countries, might be the most sensible approach to taking advantage of these differing central bank policies.

 

A Survey Of Relevant ETFs

Central bank easing is typically supportive of risk assets. There are a number of ways to think about this cause-and-effect relationship.

 

First, think of the primary equity market for the relevant central bank’s economy. The funds that provide exposure to these relevant parts of the investment universe include:

 

Second, while deflationary pressures are still present, they’re not as strong as they were six months ago, meaning nominal interest rates have at least a possibility to rise over the next few quarters.

 

With this possibility in mind, it’s worth considering ETFs such as the PowerShares Senior Loan Portfolio (BKLN | C) or the SPDR Barclays Short Term High Yield Bond ETF (SJNK | B-99). Both should perform well in a rising-rate environment.

 

Currency Hedging

Third, and not least, a strengthening dollar—our base-case for several months—is likely to continue, impacting everything from international equity returns to commodity prices. Here there are all kinds of choices:

 

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