By Norm Miller, Senior Investment Counselor 

Total returns from foreign and emerging equity markets are comprised of both a local return and a currency return (converting foreign currency back to the US dollar). The currency return component may be positive or negative. The US dollar strengthened significantly against the basket of world currencies in 2014, lowering returns in the foreign equity markets for US investors.

Factors to consider in hedging currency risk:

  • Currency risk is less volatile than equity risk
  • The cost of hedging
  • How large is the foreign exposure

For example, the currency return of the Euro fluctuated between 20.20% and -12.90% and the Japanese Yen ranged from 23.24% to -17.73% over the last 15 years. In some years currency effects will have a positive effect on US returns, but as we saw in 2014, it had an approximate 11% negative effect on foreign stock performance. Foreign stocks had a return of around 6.5% in local currency in 2014, but this became a return of -4.3% in US dollars.

Currency returns helped foreign stock returns in 2003, where foreign outpaced US returns by around 11%, even though local returns of foreign stocks were around 9% lower than US stock returns – an approximate 20% currency return effect. We live in a US centric environment, so we should not focus on short term negative currency effects – we must focus on the long term benefits of a globally diversified equity portfolio.

The expected currency return over the long-term is around 0%, so cost of hedging would reduce total return to client’s portfolios over the long term. This is why Versant does not hedge currency risk in equity markets.