How to buy international stocks if the dollar stays strong

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Many financial firms say U.S. investors should own foreign stocks as well as domestic stocks. The problem is that when you own foreign stocks you get exposure to the currency of the country where a stock is domiciled. That means in addition to the stock’s performance, your total return will include the performance of the foreign currency translated into U.S. dollars.

Currency moves can be bigger than stock moves. Currency moves can either enhance a positive stock return or wipe it out altogether, turning it into a loss. Alternatively, currency moves can amplify a negative stock return or reverse it, turning a loss into a gain.

Lately foreign currencies have faltered versus the dollar (DXY) , and that has hurt the returns in dollars of U.S. investors with a foreign stock allocation.

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For this reason, a class of exchange-traded funds hedges currency exposure, leaving dollar-based investors with only the stock return and neutralizing the currency-generated headwind or tailwind.

Fund companies providing full suites of currency-hedged foreign equity ETFs include iShares and Deutsche Asset Management. The Deutsche suite clocks in slightly cheaper than its iShares counterpart. The Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF) levies a 0.35% expense ratio, and the Deutsche x-trackers MSCI Emerging Markets Hedged Equity ETF (DBEM) costs 0.65%. By contrast, the iShares Currency Hedged MSCI EAFE ETF (HEFA)  costs 0.36%, while expenses for the iShares Currency Hedged MSCI Emerging Markets ETF (HEEM)  run 0.71%.

Asset management firm AQR argues that unhedged investors in foreign stocks historically have incurred increased volatility without any boost in performance, due to the foreign currency exposure. This is the worst of all possibilities, according to the modern way of looking at investments — more volatility, but no commensurate gain.

It’s true that currency’s impact on stocks tends to lessen over time. Hedged and unhedged performances for foreign equity indexes tend to converge for multi-decade periods. And even the most recent 10-year period produces some convergence when compared to three- or five-year periods.

But not all investors can wait decades. For those investors, a currency hedged ETF may be more prudent.

That said, the dollar’s rally may be over. The messages from the Trump administration are mixed on this. Treasury Secretary Steve Mnuchin has argued for a strong dollar, but a weak dollar would encourage American exports, which Trump generally wants to boost. If the dollar weakens, being unhedged on foreign stock holdings (having exposure to foreign currencies) would be the better strategy.

Yet your portfolio doesn’t have to be fully hedged or fully unhedged. You can split exposure between a currency-hedged fund and a non-hedged offering. That way, an investor gets some foreign currency exposure, just not the full amount.

Whatever you decide — fully hedged, fully unhedged or partly hedged — don’t try to be differently hedged at different times. Making currency bets is beyond the scope of both individual investors and financial advisers.

One other possibility: avoid foreign stock exposure altogether. Most financial advisers don’t recommend that, especially now that foreign stocks appear cheaper than domestic stocks on a variety of valuation measures. But veteran investors Warren Buffett and Jack Bogle seem to think a purely domestic portfolio is fine. After all, about half the profits of the companies in the S&P 500 (SPX)  come from outside of the U.S., and many of those companies implement their own currency hedge on foreign revenues and expenses.

John Coumarianos

Source:http://www.msn.com/en-us/money/mutualfunds/how-to-buy-international-stocks-if-the-dollar-stays-strong/ar-AAmURoK