The Downside of Hedging Currency Risk for Stock Investors
The U.S. dollar’s weakness this year has shown the downside of hedging currency exposure when investing in overseas stocks.Investors are taking note, pulling money out of currency-hedged exchange-traded funds after heavy buying last year, as the funds proliferated.
The rush of money into the hedged funds—and the recent movement out—is evidence that investors were chasing performance, says Ben Johnson, director of global ETF research at Morningstar Inc. MORN 0.55 %
Investors “have a near-zero chance of regularly and effectively timing currency movements,” Mr. Johnson says....
The outflows from currency-hedged ETFs tracked by Morningstar began in September. After taking in nearly $41.8 billion from January through August of 2015, the funds experienced net outflows of $1.8 billion from September through December. Nearly $6.5 billion more flowed out in the first three months of this year, says Morningstar, which currently tracks 48 currency-hedged ETFs.
There is an argument to be made for consistently hedging currency exposure—to focus on the returns of the underlying securities—and one for accepting currency risk as another variable in a diversified portfolio. But shifting between hedged and unhedged investments is essentially another variation of market timing and tough to do successfully.
“People are chasing the performance of the U.S. dollar,” says Paul Bosse, a principal in the Vanguard Group’s investment strategy group. “Is that really a surprise? We’ve seen those sorts of chasings go throughout the years
Some advisers who moved into hedged international-stock funds in recent years sold as they became less bullish on international shares in general.
For example, Jeffrey Carbone, co-founder and senior partner at Cornerstone Financial Partners Inc. in Huntersville, N.C., began investing in a dollar-hedged European-stock ETF in December 2014. But seeing slow global growth and anticipating a weaker dollar, he sold a portion of that position last year and the remainder in January. Mr. Carbone says his portfolio is now overweight in U.S. stocks and underweight in international equities.