Summer Vacation For Currency Hedges

June 04, 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 John Forlines III, chairman and chief investment officer of Long Island, N.Y.-based JAForlines Global.


You may remember this line from your high school English class when you read Julius Caesar:


"Take the [currency] when it serves or lose our ventures."


It's Brutus' courageous exhortation to fight a battle against Caesar's loyalists out to avenge his death and, you may remember, it had very bad consequences.


For global investors, misunderstanding or miscalculating currency exposure has had a major impact on returns over the past 15 years. For U.S. politicians and for many in the financial media, failing to understand the role currencies play in global trade is a disaster in the making.


I invoke Shakespeare and politics to frame this question of currency hedging a bit more carefully than might be the norm. After all, currency hedging has gotten a lot of attention in the past few years, and U.S. investors investing in Europe and Japan need to understand that they have to be very open and flexible when they ask themselves whether they should hedge currency exposure.


As a firm focused on global macro investing, we’re definitely remaining flexible. That means that regarding our Japanese exposure we're mixing the iShares MSCI Japan ETF (EWJ | B-99) and the hedged iShares MSCI Hedged Japan ETF (HEWJ | B-68). We'd been about evenly split, but we're biased just now to a bit more hedged positions in the portfolios. We think that the yen's recent steadiness against the dollar is likely to give way to bit more weakness, though not quite like what we've seen in much of the past two years. 


But first, I want to lay out why it is that investors need to remain open about currencies and, no less important, describe the dangers of not being open.


Go With The Flow

The subtext for the substitution "currency for current" is instructive: Both words descend from the medieval Latin currere “to run.” When currency entered the common vernacular in the 1650s, it was defined as “condition of flowing.”


Many American politicians and investors realize that most assets—especially equities and fixed income, as well as credit indicators like interest rates and liquidity—can be manipulated.


But currencies, particularly those dominating global trade today—the dollar, the renminbi, the yen and the euro—are different. They reflect the “condition” of their issuing-governments’ underlying economic policies, problems and behaviors.


The debate in Congress and the financial media over the Trans-Pacific Partnership trade deal reflects a dangerous misperception.


Beware Poorly Informed Politicians

For years, an unlikely alliance of left- and right-leaning politicians in the U.S. has sought to defend American jobs from what they deemed unfair trade practices. More to the point, if we could stop “currency manipulation,” then the trade deficit would narrow and jobs would stay home.


This ludicrous argument is a shot at Asia generally and at China in particular.


China accounts for roughly half of the U.S. merchandise deficit, and has for the past decade. Yet the renminbi has risen more than 30 percent against the dollar since 1995. 



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