A 50% currency exposure; something we have long called the “hedge of least regret,” and never has that seemed more true than this year. The U.S. dollar has been on an epic tear, up about 19% year-to-date (YTD) against key trading partners as measured by the ICE U.S. Dollar Index, the best year since 1985 (CNBC, September 26). An aggressive Federal Reserve has pushed up interest rates further and faster than many of its central bank peers and that, in turn, has altered capital flows in favor of the higher yielding U.S. currency.
The impact of a higher dollar falls most heavily on exporters and those companies that do business outside the U.S. and report earnings back to the corporate parent here. Simply put, it takes more Euros and Yen to buy the same dollar than it did last year. There is a similar negative impact on investment returns generated internationally for US investors.
It’s always hard to anticipate shifts of this magnitude. Who knew, for example, that the United Kingdom would cut tax rates, leading to a massive selloff in the British pound? Or that the Bank of Japan would intervene in the currency market for the first time since 1998 as the yen plummeted to its lowest level in two and half decades? Or that the Euro would drop below dollar parity? Those are the kinds of exogenous events that keep investors awake at night.
Even in the best of times there will be differences in regional economic performance. Central banks will sometimes move in contrary directions on interest rate policies. These times, of course, have been more challenging, as war in the Ukraine and energy and food shortages have contributed to persistently high levels of inflation and the rapid rise in interest rates around the world.
While the dollar appears poised for further gains, history has shown that the kind of price movements experienced earlier this year can quickly unwind, too. And that’s where the hedge comes in. Currency hedging allows an investor to maintain or gain exposure to international assets without making a directional bet on the dollar. It has the potential to lower volatility as well by dampening currency swings. It is, in short, a hedge against the unexpected.
One way to gain neutral currency exposure to the international markets is the IQ FTSE International Equity Currency Neutral ETF (HFXI). HFXI utilizes a 50% hedge to provide ballast against currency fluctuations, while maintaining exposure to international equities. This simple concept of a ‘best of both worlds’ exposure, both participating in a portion of foreign currency strength, and dampening the negative impacts of US dollar strength, provides an investor with a neutral choice to investing internationally. Considering the sharp, and in some cases historic, movements in the foreign exchange market this year, a neutral currency approach can provide just the kind of portfolio protection that international investors are seeking.
And that brings us to one final point worth noting… While international markets have generally underperformed the U.S. of late – especially in dollar terms – that, too, is subject to change without notice. It’s not impossible to imagine a scenario where non-U.S. markets outperform and the dollar gives back some of its gains. In that instance, it would be helpful to have exposure outside the U.S. consistent with overall portfolio diversification. HFXI provides a way to do that without courting the potential “regret” of going all in on a currency. Completely hedged? Completely unhedged? Perhaps somewhere in between is best, which is why we’ve long been advocates of the “hedge of least regret.”
Past performance is no guarantee of future results, which will vary. All investments are subject to market risk and will fluctuate in value.
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This material represents an assessment of the market environment as at a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.
The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.
This material contains general information only and does not take into account an individual's financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.
Hedge -- A hedge is an investment position intended to offset potential losses or gains that may be incurred by a companion investment.
ICE U.S. Dollar Index -- The ICE U.S. Dollar Index (USDX) futures contract is a leading benchmark for the international value of the US dollar and the world's most widely-recognized traded currency index.
Before considering an investment in the Fund, you should understand that you could lose money.
The Fund will invest in securities denominated in currencies other than U.S. dollars (foreign currencies) and much of the income received by the Fund will be in foreign currencies, but the Underlying Index and the Fund’s NAV will be calculated in U.S. dollars. Furthermore, the Fund may convert cash in U.S. dollars to foreign currencies to purchase securities. Both the Fund’s ability to track the Underlying Index and Fund returns in general may be adversely impacted by changes in currency exchange rates, which can occur quickly and without warning. The Fund uses various strategies to attempt to reduce the impact of changes in the value of a foreign currency against the U.S. dollar. These strategies may not be successful. Derivatives are investments whose value depends on (or is derived from) the value of an underlying instrument, such as a security, asset, reference rate or index. Derivatives may be difficult to sell, unwind or value. The use of a derivative may be more volatile than the underlying direct investment. The Fund invests in the securities of non-U.S. issuers, which securities involve risks beyond those associated with investments in U.S. securities. The performance of the Underlying Index and the Fund may deviate from that of the markets the Underlying Index seeks to track due to changes that are reflected in the sector more quickly than the quarterly rebalancing process can track. Securities in the Underlying Index or in the Fund’s portfolio may also underperform in comparison to the general securities markets. The strategy used by the Advisor to match the performance of the Underlying Index may fail to produce the intended results. Mid capitalization companies are generally less-established and their stocks may be more volatile and less liquid than the securities of larger companies.
“New York Life Investments” is both a service mark, and the common trade name, of certain investment advisors affiliated with New York Life Insurance Company. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC and serves as the advisor to the IndexIQ ETFs. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.