“The rise in the U.S. dollar may have American investors wondering if they should be hedging their international investments. That’s because a strong U.S. dollar can dent international stock returns. For example, when investments in the eurozone are translated back to dollars, it takes more euros to buy a dollar, cutting into dollar-denominated returns. We believe the decision to hedge currency exposure depends on your time horizon. If you’re investing for the short term, hedging might make sense. But if you’re investing for the longer term, you’re not likely to benefit much, if at all, from hedging.
Here, we are focused on hedging currency for international stock investments, not trading or investing in currencies or international bond portfolios. In a currency-hedged professionally managed portfolio, investment managers buy stocks as they would for a regular portfolio. The manager then adds short-term forward contracts, which are arrangements to exchange two currencies at a pre-agreed exchange rate sometime in the future—often 30 days. The aim is to minimize the effect of currency movements on the portfolio return. But minimizing the effect of currency movements doesn’t mean entirely eliminating them. Because currency hedges are often adjusted monthly, dramatic currency moves within that time frame can still create currency risk within a portfolio.
Here are five things—two positive and three negative—to consider when thinking about the impact of currency on your international portfolio. Read more »