The volatility reduction benefits of hedging hold during both increasing and decreasing euro environments.
They are particularly impressive during declining euro environments, with risk reduction of more than 25 percent, on average. In addition, the correlations of the currency-hedged versions of these indexes are all lower than their unhedged counterparts.
The obvious conclusion is that long-term investors probably only want to hold the foreign currency if they have a strong opinion that it will appreciate. It also makes sense to hedge a currency that investors feel will be weak.
What is less obvious is the conclusion that if you are neutral on the foreign currency (or have a long-term view that currencies are a zero-sum game) then investors would be well-served to hedge the currency exposure. The resulting lower volatility and correlations of the component parts will benefit the risk/reward profile of the overall portfolio.
Most clients, despite their claims to the contrary, don’t have a three- to five-year time horizon, much less a 20-year horizon. Long time horizons are necessary for the “currency moves are a wash” theory to apply.
As we have seen, currency moves can cut deeply if investors are on the wrong side of a large short- to intermediate-term move. Investors with shorter time horizons would do well to consider being dynamic between hedging and not hedging.
Currency-hedged ETFs are a great way to get these exposures. So, regardless of whether they are “hot” right now, or it feels like they are being over-marketed in the current environment, we believe they deserve serious consideration for a global investor’s portfolio.
Accuvest Global Advisors (AGA) is a registered investment advisor based in the San Francisco Bay Area. Founded in 2005, AGA has drawn considerable recognition in the industry for its work in building global strategies through the use of single-country ETFs. For more thought leadership and firm updates, visit www.accuvestblog.com, www.twitter.com/Accuvest or email [email protected]. For a list of full disclosures, please click here.