For U.S. investors, foreign currency fluctuations can be a critically important – but much overlooked — factor to consider when investing in international stock or bond fund. If a foreign currency is appreciating relative to the U.S. dollar, it can provide a boost to returns, but if the currency is weakening, it can detract from them.
Because international funds are usually owned for diversification purposes, most expose investors to the foreign currencies that underlie the stocks or bonds they invest in. However, there have been some more recent funds that hedge (or remove the impact of) the currency exposure, providing more options for investors. And while for many investors currency matters are a secondary consideration (at best), over the past few months there have been a couple of interesting examples of how much of an impact currency movements can have on returns.
Up until very recently when the Italian election results spooked investors, European equity markets had enjoyed a robust rally since last summer when the European Central Bank removed some of the systemic risk concerns that produced jarring declines earlier that year. As confidence has slowly returned, it has also given a big boost to the euro, which was under considerable pressure when there were worries that the Eurozone might break apart.
After reaching a low on June 1st last summer, an ETF that tracks European stocks (EZU, the black line on the chart to the right) rose by 45% through February 1st. At the same time, the value of the euro increased by 10% (FXE, the blue line), essentially providing a tailwind that amounted to approximately 22% of the return of EZU. Another ETF that invests in European stocks but hedges the currency (HEDJ, the brown line) also performed well, since it gained 26% while the S&P was up 20%, but it left a considerable amount of returns on the table since it didn’t benefit from the increase in the euro. In this case, it benefitted U.S. investors to be exposed to both the stocks and the currency, since both appreciated together.
A different dynamic has taken place in Japan. After elections led to a leadership change late last year, the value of the yen has plummeted as the new prime minister openly advocated for a weaker currency in an effort to jumpstart the economy. Interestingly, this has helped spark a huge rally in the Japanese stock market, as investors begin to discount what they perceive to be a big boost to economic growth (particularly in exports).
From a recent low on November 14th, an ETF that tracks the MSCI Japan Index (EWJ, the black line on the chart to the right) rose by 17% through its recent high on February 11th, outperforming the S&P 500 (which was up by 12.5%). However, the Japanese yen actually fell by nearly 15% during that time (FXY, the blue line). Meanwhile, another Japan ETF that removes the effect of currency fluctuations (DXJ, the brown line) soared by 34% over the same period! In other words, while Japanese equities were big outperformers, the plunge in the currency effectively ‘robbed’ a large portion of the returns for U.S. investors. In this case, investors would have wanted exposure to the stocks without exposure to the currency.
These are just two examples of the impact currency movements can have when investing internationally. As a result, as we scour the globe looking for investment opportunities, our evaluation of the underlying currency is an integral part of the process.
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