International ETF’s May Provide All the Currency Exposure an Investor Needs

Currency is gaining more and more acceptance as a valid asset class as investors look to diversify out of more traditional holdings, such as stocks, bonds and real estate. As the exchange traded fund market grew, so did the variety of choices available to investors. As a whole, more than $3.7 billion moved into currency based ETFs and two of the most popular, the WisdomTree Dreyfus Emerging Currency (NYSE:CEW) and the WisdomTree Dreyfus Chinese Yuan (NYSE: CYB) saw inflows of $176 million and $200 million respectively. The Forex market is the largest and most liquid of all markets, moving nearly $3 trillion worth of trading each day. However, just because an asset class in now available for regular retail investors doesn't necessarily mean, they need to run out an add it to a portfolio.   

Enough Exposure Already

International stock and bond funds are also making larger percentages of modern portfolios as exposure to many different countries and continents are now possible. It's in these portfolio allocations that currency investor's maybe inadvertently doubling up on their exposure. A U.S. fund such as iShares MSCI Canada Index (NYSE: EWC) owns stocks priced in Canadian dollars (Loonies). Many investors often do not realize that there is a two part total return quotient to foreign assets; how the stock performs in its local currency and how that currency performs relative to the dollar. Buying the iShares Canada ETF gives investors a one-two punch of foreign stocks and enough currency exposure.

 Using the Canadian ETF as an example, the MSCI index which the fund is based, increased approximately 31% from the start of 2009 to mid-April when priced in Loonies. However, due to the Loonie surging against the Greenback, U.S investors saw a return of nearly 60% during the same time. Similar for investors in Brazil (NYSE: EWZ) and Australia, (NYSE: EWA), vastly appreciating currencies versus the dollar have boosted returns for the ETFs, in addition to the underlying stock gains.

However, this effect can work both ways. As the dollar has been strengthening lately, as the debt problems in Greece and Spain intensify and investors flock towards relative safety. The currency relationship is helping to exploit downward returns. The U.K. is suffering from its own debt and banking crisis. The Pound has recently been falling and investors in the iShares MSCI United Kingdom Index (NYSE: EWU) have seen their investment stifled versus the index.

In addition, investors can gain or lose based on any dividends paid by the underlying stocks. As dividends are paid in Kiwi's, Loonies or Baht and translated into dollars, there again exchange rates can have an a dramatic effect.

What An Investor Can Do

The purpose of this article isn't to tell investors to stay away from currency exchanged traded products, but to understand how the total return of their portfolio works. If you believe that the Swedish Krona (NYSE: FXS) will rise or fall versus the dollar, invest away. Just understand how holding the Global X FTSE Nordic ETF (NYSE:GXF) will also be impacted by those same changes.

Investors wanting to take currency out of the equation from their foreign investments due have some new choices from WisdomTree. Both the WisdomTree Japan Hedged Equity (NYSE: DXJ) and the WisdomTree International Hedged Equity (NYSE: HEDJ) use derivatives to smooth out the currency bumps in each fund. For Japan, the MSCI index through March was up nearly 5.7%. However, when priced in Yen, the Index gained 8.2%. These investments are perfect for investors looking to avoid any of the additional volatility associated with currency as well as save on the transaction costs of holding individual currency hedges or exchange traded funds. While, the funds are new, I expect them to catch on as more investors realize exactly what their portfolios contain. I also expect that newer internationally hedged products will hit the market, if these funds prove successful.

Look Before You Leap

As more and more investors look for ways to diversify and reduce risk from their portfolios, currency investing will certainly continue to grow. However, individual investors should understand how a currency product fits in their portfolios, before purchasing one. Most investors already have enough currency exposure within their international holdings and may not need to participate in that market at all.

Disclosure Statement: At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.