ETF Experts: Hedging Currency Risk Is Cheap, Prudent and Getting Easier

Despite the growth in assets under management in currency-hedged ETFs, most actively managed equity fund managers still don’t hedge currency risk, and that probably is at the detriment of their clients, agreed panelists at the Morningstar ETF conference in Chicago on Wednesday. 

The panel, moderated by Patricia Oey of Morningstar, consisted  of Arne Noack, director of exchange-traded product development for Deutsche Asset & Wealth, Luciano Siracusano, chief investment strategist for Wisdom Tree, and Francisco Torralba, senior economist for Morningstar. Both Noack and Siracusano thought at least a 50/50 currency hedged portfolio was a prudent start, especially with the global currency and equity volatility that’s been in play over the past few years.

“If currencies and equity markets are correlated, they have certain benefits in the long run. Not to hedge can have a positive risk return due to non-correlation,” said Noack. “We found currency is correlated in such a way that it is additive. Ultimately, if you invest internationally without hedging currency risk…you are increasing volatility in a portfolio by virtue of foreign equities and foreign exchange. Taking one out can … reduce this risk and volatility.” 

In viewing the global currency landscape, closer to home all panelists thought it was a long shot that the Fed would raise rates in December, which would be a key driver in global currency moves. 

Torralba noted that the global economy is slowing down and “soon markets are going to catch up to the fact that we are far along in the business cycle in the U.S. So the Fed won’t raise because the economy [would get] shakier.” Noack agreed, saying there was a 50/50 chance the Fed would raise rates, adding, “the globalized economy is not in fantastic shape. What has become apparent is the Fed is conscious of its global responsibility; it’s not only setting U.S. rates and impacts U.S. policy, but due to interdependencies globally, whatever they do impacts somewhere else.”

Siracusano thought there was only a one in three chance of a December rate increase, due to the global economic outlook. “The Fed doesn’t want to complicate the global scene…it’s the banker of last resort and [its decisions have a] potential for a chain reaction in global markets.”

However, the panelists concurred that the U.S. dollar would continue appreciating, Siracusano adding “this is the third big bull rally for the U.S. dollar. In the 1980s under Reagan, the dollar rallied 50% over five and a half years. Under Clinton it rallied 35% over six and a half years. Now it’s a 30% rally in four years…the key question is what the market currently anticipates.”