3 things to know about international investing and currency

As we enter another year of volatility and a strong dollar, we explore a new way to hedge for currency risk in your international investments.

While investing internationally is important to having a diversified portfolio, it’s not likely to get any easier this year. As world monetary policy continues to diverge — in other words, Europe and Japan remain committed to rock bottom interest rates while the U.S. Federal Reserve raises ours — expect currencies to continue their bumpy ride.

Looking at volatility in the past year on the DXY index, which is a measure of the value of the U.S. dollar relative to a basket of major foreign currencies, we’ve seen an increase from 6% to 12%. And it’s becoming increasingly difficult to predict whether it will go up or down.

currency volatility on the rise dxy

In The BlackRock List, we describe why we believe the U.S. dollar will remain strong in 2016 amid global market volatility. While we see potential opportunities abroad, we suggest that American investors think about how to mitigate currency risk in their overseas investments.

Zigging When You Should Be Zagging

What you see above relates directly to your international portfolio returns, because when you invest in a foreign market, you are usually also investing in that foreign currency. Think of it as a simple equation:

currency investing equation

This equation tells us that exchange rate movements have the potential to either add to the returns in a portfolio or diminish them — and in the worst case scenario, they may even lead to losses.

Last fall, I shared considerations for building a currency hedged strategy. Being hedged — or basically taking the exchange rate effect out of the equation — at the right times can really make a difference in the performance of your portfolio.

The truth is that timing currency movements is not an easy task, and data shows us that investor decision-making often lags market developments. In other words, many investors often buy and sell at the wrong times. This can happen in any part of the market, not just with currencies. However, the volatility inherent in currencies makes it critical to make the right decision at the right time. Take a look at the disconnect between the strength of the U.S. dollar v. the Japanese yen and flows into currency hedged funds since April 2014.

currency hedged fund flows and market timing

So, the real question is whether you feel confident in your ability to predict currency movements in an increasingly volatile world. If the answer is yes, then using traditional fully hedged exchange traded funds (ETFs) may be the right tool for targeting specific short-term opportunities or seeking to take currency entirely out of the equation.

If the answer is no, then the new iShares adaptive currency hedged ETFs may provide a good solution for longer-term allocations to developed international markets, Europe and Japan. With these ETFs, investors don’t need to figure out when and how much to hedge foreign markets as they are designed to dynamically adjust to changing currency environments. They take the guesswork out of managing a currency hedge in your portfolio, freeing up your time and effort to focus on other areas of your portfolio.

Adapt to Market Reality

If the first couple months of the year are any indication, it looks like 2016 will be a volatile year. So, what does that mean for investors? Let’s recap the reality of investing in today’s global markets:

  1. We continue to believe that some of the best opportunities lie abroad. Investors may seek to benefit from near-term economic stimulus in many countries, or they may want to take advantage of relatively attractive stock prices and establish long-term international allocations.
  2. As overall volatility in the markets continues, we expect currency volatility to increase and therefore become more difficult to predict. Unfortunately, many investors’ actions tend to lag the changes in the market.
  3. New solutions have made it easier than ever to address currency risk. Shifting between hedged and unhedged versions of the same exposure is a great way to take currency risk on and off, assuming you have a view on currency. If you’re investing for the long-term and prefer to not make hedging decisions, you may want to consider a dynamically hedged ETF.

 

Carefully consider the Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing.

Investing involves risk, including possible loss of principal.  International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/ developing markets or in concentrations of single countries.

The Fund’s use of derivatives may reduce the Fund’s returns and/or increase volatility and subject the Fund to counterparty risk, which is the risk that the other party in the transaction will not fulfill its contractual obligation. The Fund could suffer losses related to its derivative positions because of a possible lack of liquidity in the secondary market and as a result of unanticipated market movements, which losses are potentially unlimited. There can be no assurance that the Fund’s hedging transactions will be effective.

Investment in a fund of funds is subject to the risks and expenses of the underlying funds.

This material represents an assessment of the market environment as of the date indicated; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

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