When you invest in foreign markets, it pays to think about currency volatility. You might invest in a country where its stock market rises 10% over a year, but if the country's currency falls over that period, your profit will be reduced. Or maybe even disappear completely.
We've seen this in recent months where the crisis in Turkey has pushed the euro to its lowest level against the dollar in the last year. Sterling has also dropped.
Trump's trade wars, Brexit concerns and interest rate hikes have also contributed to currency movements this year. One way investors can manage this is with a currency hedged ETF, but they come at a cost and there aren't a huge range on offer.
Put simply, currency hedged ETFs are one of the best and most simple ways for investors to protect themselves against currency risk. You won't suffer if a currency moves against you.
Let's look at the iShares MSCI EMU ETF (CEU). This is an ETF that tracks stocks in the eurozone. It's risen 3.95% this year but would have done better if the euro hadn't fallen. However, the hedged version of the ETF, the iShares MSCI EMU USD Hedged ETF (EMUU) has returned 6.04%. This ETF hedges the euro against the dollar, so the fund hasn't suffered even though the euro has fallen against the dollar.
Christopher Gannatti, head of research Europe at WisdomTree explains that if the currency is moving then it's a good idea to try and understand why.
The euro has moved around a lot recently and this has been down to events such as Turkey, Brexit and the US president's trade discussion. While it's good for large cap multi-national exporters, that's about it as these types of events weigh heavily on foreign exchange rates.
(The graph below shows the movement of the EUR/USD in the last year)
However, Gannatti points out that while people are now talking a lot about currency hedged ETFs they have yet to move into them. "While we haven't seen flows tick up into hedge products we have seen the discussions around them increase. This year we find that investors looking at equity markets are slightly reserved as a result of the increased volatility we saw earlier this year."
The presence of a hedge is valuable when there is currency volatility in equities, commodities and also bonds.
Gannatti says: "An area where hedged ETFs are invaluable is in government bond ETFs, where it's beneficial to have currency controls. This is because while the bonds themselves usually have low volatility (and in many markets are termed the "risk-free" assets), currency volatility can impact returns and potentially reduce the 'risk free' nature of the investment. Therefore a hedge is usually a good idea to ensure your risk remains reduced."
These ETFs have also helped make hedging currency exposures a lot easier. Investors who don't have currency hedged ETFs and take a currency hit are likely to have another part of their portfolio managing the exchange rate loss.
And before currency-hedged ETFs, investors would have to short another ETF, a future, or the spot currency itself to hedge out the currency exposure in their underlying equity position, Ganantti explains. "These are more complex strategies to implement and maintain and were typically reserved for asset managers and other institutional investors."
There are a number of currency hedged ETFs on the London Stock Exchange. We have listed a number of equity focused currency hedged ETFs, however there are a number of other commodity and fixed income currency hedged ETFs also available.
ETFCURRENCYTER1 YR RTNINDEXiShares MSCI EMU USD Hedged ETF (EMUU)USD0.38%6.04%MSCI EMU 100% hedged to USD IndexiShares JPX-Nikkei 400 EUR Hedged UCITS ETF AccEUR0.25%6.64%JPX- Nikkei 400 Net Total Return EUR Hedged IndexiShares MSCI Japan EUR Hedged UCITS ETF AccEUR0.64%7.16%MSCI Japan 100% Hedged to EUR IndexiShares MSCI Japan GBP Hedged UCITS ETF AccGBP0.64%7.95%MSCI Japan 100% Hedged to GBP Net TR IndexiShares MSCI Japan USD Hedged UCITS ETF AccUSD0.64%9.98%MSCI Japan 100% Hedged to USD Net TR IndexiShares S&P 500 EUR Hedged UCITS ETF AccEUR0.20%13.81%S&P 500 Euro Hedged IndexiShares S&P 500 GBP Hedged UCITS ETF AccGBP0.20%14.76%S&P 500 British Pound Hedged IndexiShares MSCI World GBP Hedged UCITS ETF AccGBP0.55%11.22%MSCI World 100% Hedged to GBP Net TR IndexiShares MSCI World EUR Hedged UCITS ETF AccEUR0.55%10.23%MSCI World 100% Hedged to EUR IndexNomura Nikkei 225 EUR-Hedged UCITS ETFEUR0.60%14.14%Nikkei 225 Total Return EUR-hedged IndexNomura Nikkei 225 USD-Hedged UCITS ETFUSD0.60%16.53%Nikkei 225 Total Return USD-hedged IndexWisdomTree Europe Equity UCITS ETFUSD0.58%4.20%WisdomTree Europe Equity IndexWisdomtree Germany Equity UCITS ETFGBX0.35%0.45%WisdomTree Germany Equity IndexWisdomTree Japan Equity UCITS ETFUSD0.48%5.26%WisdomTree Japan Equity Index