A diversified investment portfolio has both domestic and international components, but a strong dollar can be a drag on performance.
The dollar’s recent strength has cost U.S. investors as much as 9 percent per year since 2013, and more than 2 percent per year during the last decade, according to the Leuthold Group.
How investors can mitigate the performance-drag impact has been debated for years, says John De Clue, chief investment officer of the Private Client Reserve of U.S. Bank in Minneapolis, “especially in recent years when you’ve had the dollar catch fire and become so strong.”
The concerns about the dollar’s impact on a portfolio is also heightened as investors look to non-U.S. markets in light of the high valuations of U.S. equities.
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Financial experts say there are a few options out there, but they depend on the investor’s risk tolerance, view on the dollar’s future direction and time horizon.
What to consider. Scott Opsal, director of research for The Leuthold Group in Minneapolis, says the last two factors — an investor’s view on the dollar and time horizon — should be the first consideration.
“If you think the dollar is going to weaken, you want to sit tight and go with what you got. Hedging only applies if you think the dollar will strengthen,” he says. “What we find is over a very long time, say, 20 years or more, the dollar tends to even itself out. … If you’re 30 years old and saving for retirement, let it ride. Really, currency hedging is for someone with a medium-term time horizon and has a fear the dollar will strengthen.”
For short-term and medium-term positions, De Clue says one way to mitigate the currency risk is to look at a relatively new breed of exchange-traded funds that invest in international markets, and include currency hedging as part of their construction. Because these ETFs do the work of picking the investments and offset the foreign exchange factors, De Clue calls them “an efficient solution.”
Opsal says at the most basic level, these ETFs take the local index and overlay a currency hedge on top of it. One of the biggest ETFs that offsets currency risk is iShares Currency Hedged MSCI EAFE ETF (ticker: HEFA), which tracks investment results of an index composed of large- and mid-capitalization equities in Europe, Australia, Asia and the Far East. It has $3.95 billion in assets under management and an expense ratio of 0.36 percent, or $36 per $10,000 invested. The firm also has currency-hedged ETFs for individual countries, too.
“I think that’s easily the most simple and reliable way to do it,” Opsal says. “The expenses are modest,” he says.
While a strong dollar can be a performance drag, investors can look at a strong dollar trend as an investment opportunity in itself. Investors can buy ETFs that only trade a currency, such as one based on the yen or the euro.
Opsal says investors can also look for ETFs that track the dollar against a basket of currencies, such as PowerShares DB US Dollar Index Bullish Fund ETF ( UUP). It has $723 million in assets under management and an expense ratio of 0.75 percent. This ETF uses an index to track the dollar’s value against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.
PowerShares also has similar fund that looks to benefit if the dollar falls, PowerShares DB US Dollar Index Bearish Fund ( UDN). It has $37 million in assets under management and an expense ratio of 0.75 percent.
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Other options. Not everyone recommends retail investors use currency-hedged ETFs. Anthony Conte, managing partner of Camp Hill, Pennsylvania-based Conte Wealth Advisors, says there are other ways to offset the dollar strength. He likes focusing on companies that have the majority of their sales based in the U.S. and thus more dollar-denominated revenue.
“Almost always, the average investor needs to stick with a diversified portfolio. It doesn’t mean you can’t cherry pick some opportunities,” he says.
Consumer cyclical-focused companies, which are usually retailers, is one sector that may benefit from a strong dollar.
“If the dollar is strong, the price of goods tends to remain lower,” he says. “It takes fewer dollars to buy those things, and people see inexpensive costs.”
Additionally, investors can look at medium- and smaller-capitalization companies as many of those firms predominantly generate revenue domestically.
Tim Courtney, chief investment officer of Exencial Wealth Advisors in Oklahoma City, says the focus on the currency fluctuations in portfolios may be too narrowly focused, especially if people look holistically at their personal finances.
“One benefit of a strong dollar is we’ve had very low inflation (compared to what) we’ve had in many, many decades,” he says, which has helped people’s purchasing power.
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While it’s worth it to be aware of performance drag from the stronger dollar, as long as an investor doesn’t have a big exposure to non-dollar denominated assets, “I wouldn’t be overly concerned,” Courtney says.
Further, he questions investors having all of their investments tied back to the dollar, especially when taking the long view of investing.
“We don’t think that’s the right way of looking at diversification,” Courtney says. “One reason is to get exposure to other currencies. While the dollar is strong now, we can look back five years from now and see whether the dollar weakened. It would be horrible if the dollar weakened, sending inflation higher, and your investments are not hedged that at all. That’s the real risk having of everything hedged back to the dollar.”
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How the Strong Dollar Affects Your Portfolio originally appeared on usnews.com
