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Time for Currency-Hedged International ETFs?

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The policy differential across the globe led investors in the ETF world to see the impact of currencies on their foreign holdings. This is truer in the light of heightened rising rates fears in the United States and rock-bottom rates in the Euro zone as well as in Japan. Some emerging economies too continue easy-money policies.

The Fed has enacted a 25-bp rate hike in March and a 50-bp rate hike in May. Markets are pricing in another 190-basis-point rate hike in 2022. Hence, the greenback has been gaining strength.

Many currencies are slumping against the U.S. dollar, which is having an adverse impact on stock prices when U.S. investors repatriate returns earned from foreign shores. Invesco DB US Dollar Index Bullish ETF (UUP - Free Report) is up 8.3% this year.

Yen

Yen has been trading at a two-decade low against the greenback. Devaluation in currency is always boon to the export-oriented nation like Japan. A weaker yen makes Japanese products more competitive on the global market, boosting the profit margins for their key businesses.

In recent months, Japan has been receiving what it wanted for long, though fast-rising food and energy costs have been bothering the economy amid a scenario of moderate inflation. Invesco CurrencyShares Japanese Yen Trust (FXY - Free Report) is off 10% in the past six months.

Euro

Invesco CurrencyShares Euro Currency Trust (FXE - Free Report) is down 7.3% this year.Though the euro is close to the parity with the greenback, FXE is still off 2% past month. If the Fed maintains its aggressive rate hike momentum in the near term, the greenback may gain further.

Emerging Markets

WisdomTree Emerging Currency Strategy Fund (CEW - Free Report) is off 3% past month. Most emerging market currencies will likely fall over the medium term. Notably, emerging markets are commodity-rich and hence benefited to a large extent due to the latest commodity rally.

But a Reuters article published in early April revealed that even currencies that have gained from the ongoing commodity rally and their respective central banks' policy tightening, like the Brazilian real and the South African rand are forecast (by economists) to lose about half of those gains in a year. That article indicated that the Mexican peso - a classic emerging market foreign exchange hedge — is expected to give up more than three times its gains for this year in 12 months.

International Stocks Cheaper Than U.S. Ones

Per an article published on Wall Street Journal, U.S. stocks appear pricey relative to their international counterparts. Even though it has declined 16% to start 2022, the S&P 500 trades at 16.8 times its projected earnings over the next 12 months, which is still above the average multiple of 15.7 over the past 20 years, according to FactSet, as quoted on Wall Street Journal.

By comparison, Hong Kong’s Hang Seng trades at 9.5 times its projected earnings, Japan’s Nikkei 225 trades at 14.3 times earnings and Germany’s DAX trades at 11.4 times, per the WSJ article. Only the benchmarks in Belgium, Portugal and Saudi Arabia, as well as the tech-heavy Nasdaq Composite, have higher valuations based on future earnings than the S&P 500, according to data available on FactSet (read: Are International ETFs Cheaper Than U.S. ETFs?).

Morgan Stanley strategists are also overweight on the FTSE 100, as quoted on a Bloomberg article. Notably, the FTSE 100 represents more than 80% of the London Stock Exchange's market capitalization.

Currency Hedged ETFs to Rule

Thanks to this currency issue, investors need to be vigilant while picking up foreign assets and consider the dollar’s possibility of gaining more strength following further hikes in interest rates. There isn’t anything more unfortunate than seeing one’s substantial portfolio additions fail because of soft foreign currency.

The above discussion has made the importance of hedging clear to many investors who may not have realized that a bet on a foreign market is not only to do with purchasing stocks or bonds in the country but a lot to do with currency translation.

This is because the ongoing and potential dollar strength may eat up the returns earned from the countries marked with immense bourse potential but weak currencies.  Hence, to ride out this currency concerns, it is better to opt for currency hedged ETFs in the near term.

For investors intrigued by this strategy, there are a few options currently on the market. Below, we briefly highlight some of the currency-hedged ETFs that have beaten down the S&P 500 (down 0.8%) past week.

Winning ETFs of Past Week

WisdomTree Germany Hedged Equity Fund – Up 3.73%

WisdomTree Europe Hedged SmallCap Equity Fund (EUSC - Free Report) – Up 2.9%

WisdomTree Europe Hedged Equity Fund (HEDJ - Free Report) – Up 2.6%

Xtrackers MSCI Eurozone Hedged Equity ETF (DBEZ - Free Report) – Up 2.5%

Franklin FTSE Europe Hedged ETF – Up 2.5%

iShares Currency Hedged MSCI Eurozone ETF (HEZU - Free Report) – Up 2.5%

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