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 is by Larry Whistler, president and chief investment officer of Buffalo, New York-based Nottingham Advisors.
The dollar has appreciated by nearly 17 percent over the past year against major foreign currencies, impacting U.S. exporters and investors alike. With global central banks actively manipulating short-term interest rates and bond markets, the resulting currency volatility has added an extra layer of analysis and decision-making with regard to investing in non-U.S. asset classes.
What I'm driving toward is a straightforward question: To hedge, or not to hedge? That is the question!
The short answer is yes, though investors can choose to position portfolios to benefit from further dollar strength with either a currency-hedged equity fund like the Deutsche X-trackers MSCI Japan Hedged Equity ETF (DBJP | B-76) or with an ETF that delivers returns of the dollar against an index of foreign currencies such as the WisdomTree Bloomberg US Dollar Bullish Fund (USDU | 67).
Despite recent pullbacks, the dollar has had an impressive run over the past year against major foreign currencies. Moreover, we believe the factors that triggered the surge will sustain over the next few years as the U.S. economy returns to long-term trend growth.
As shown above, past moves in the dollar tend to be longer term in nature and it's likely recent dollar strength will persist a while longer, although probably not in the nearly linear fashion of late.
Comparing Hedged And Unhedged Returns
Over the past 12 months, the MSCI EAFE Index gained 15 percent in local currency terms. But when translated back into dollars, however, investors barely broke even, eking out a barely positive return of just 0.38 percent. This return discrepancy is even more pronounced in the eurozone.
Since its inception in July 2014, the iShares Currency Hedged MSCI EMU ETF (HEZU | D-43) is up nearly 20 percent, while its unhedged counterpart, the iShares MSCI EMU ETF (EZU | B-79), is only up 1.5 percent.
The story holds true in Japan as well. The iShares MSCI Japan ETF (EWJ | B-99) has returned 16.8 percent over the past year, while its hedged cousin the Deutsche X-trackers MSCI Japan Hedged Equity ETF (DBJP | B-76) has returned almost twice as much, at 34.4 percent.