Heavy inflows into currency-hedged ETFs this year and last bear witness to the undeniable popularity of strategies which mitigate currency risk, especially for dollar-referenced investors. According to S&P Dow Jones Indices (S&P DJI), a leading provider of indices, investors are right to be considering currency management and this is particularly pertinent in the near to medium term for USD investors.

The US dollar could rally further against other major currencies.

US economic strength, significant quantitative easing policies from the European and Japanese central banks and the possibility of US interest rate rises means there is a strong possibility that the US dollar will continue to rally against other major currencies.

Commenting, Aye Soe, Senior Director of Research and Design at S&P DJI said: “For a USD investor, currency hedging has long been part of fixed income portfolio management, as currency volatility plays a significant role in international bond returns. However, it is not as prevalent in equity investing. That has been changing as the spreads between hedged international equity portfolios and unhedged international equity portfolios has widened considerably in recent months, and they may widen even more, all else being equal, if other major currencies continue to weaken relative to the US dollar.”

Investors can face significant losses in asset returns due to currency moves. S&P DJI draws attention to the return of the S&P Global Ex US Large Mid BMI Index which returned -3.0% in 2014, while its USD-hedged counterpart delivered 6.0% during the same period, representing a performance difference of over 9%.

Currency-hedged strategies look to offset currency risk and deliver the investor a return which is determined by the local currency return of the assets, not the currencies in which they are based. This is achieved by entering into derivative contracts on currency pairs, such as currency forwards, which are based on the value of the assets in the portfolio that are denominated in the currency being hedged. Many strategies rebalance these contracts on a periodic basis, e.g. monthly, in order to lessen transaction costs. While this does not result in a “perfect currency-hedge”, it strikes the balance between effectiveness and cost.

Recent currency moves and the historically low cost of these strategies – due in part to narrow interest rate differentials between developed economies – have increased their appeal. For investors with the appropriate time horizons, those unwilling to bear currency fluctuations, or those with a strongly held outlook for currency market direction, a hedged strategy can make perfect sense.

Bond investors in Europe can get access to US dollar-hedged ETFs from providers such as iShares and UBS, for example, the iShares $ Corporate Bond Interest Rate Hedged UCITS ETF (LQDH LN) and the UBS ETF – Barclays Euro Area Liquid Corporates 1-5 Year UCITS ETF hedged to USD (CBEU5U SW).

There are a wealth of ETFs available for equity investors looking to implement a currency-hedged strategy. As leading providers of currency-hedged products, UBS offers an extensive suite of currency-hedged ETFs covering a range of countries and regions. WisdomTree Europe offers dollar-hedged versions of their Japan and Europe equity ETFs, as well as a sterling-hedged German equity ETF. These ETFs are positioned to benefit from the QE programmes in Europe and Japan and target dividend-paying companies generating revenues outside their domestic markets.

Similar products are available from Source such as the currency-hedged versions of their Stoxx Japan Exporters and Stoxx Eurozone Exporters ETFs. Lyxor provides hedged versions of their alternatively weighted JPX-Nikkei 400 ETF, which selects and weights constituents based on profitability. Additionally, Lyxor offers currency-hedged ETF share classes on the Euro Stoxx 50 Index.