Chances are, you own some foreign stocks either directly or through a mutual fund. What if foreign stock prices rise but the strong US dollar erases your profits? That’s the danger for a US investor as the dollar gains in value against foreign currencies, which means that it takes more euros, pounds, Swiss francs, etc., to equal the value of a dollar. In most cases, when a US fund manager invests in a stock on a foreign exchange, the stock price must be translated to dollars. And since 2014, the dollar has appreciated an average of 24% against other major currencies, diminishing returns on foreign investments for US investors.
Remedy: Invest in exchange-traded funds (ETFs) that “hedge”—or lock in—the price of foreign currencies so that currency fluctuations don’t affect the value of your investments. There are currency-hedged ETFs for investing in single countries or multiple countries—dozens have been launched in the past few years, bringing the total to about 80. Their performance in 2016 was 5 to 10 percentage points better in some cases than that of similar unhedged funds.
Caveat: If the US dollar weakens, currency-hedged ETFs will underperform traditional ones. But I think it’s likely the dollar will remain strong for several more years because interest rates are rising in the US while they are flat or falling in many developed nations.
My two favorite currency-hedged ETFs for foreign-stock exposure now…
WisdomTree Europe Hedged Equity ETF (HEDJ) tracks about 130 large-cap stocks in 11 European countries. It gained 10% in 2016 versus a drop of 0.25% for a comparable unhedged ETF.
iShares Currency Hedged MSCI EAFE ETF (HEFA) follows the MSCI EAFE Index composed of about 930 large and mid-cap stocks in about 25 developed countries other than the US and Canada. Its 2016 return was 6.4% versus 1.4% for a com-parable unhedged ETF.