The world is heading towards a currency war as a number of countries are choosing loose monetary policies to stimulate the sagging growth and prevent deflationary pressures. This is in stark contrast to the U.S. Fed policy of tightening its stimulus program by wrapping up QE3. The diverging central bank policies have propelled the U.S. dollar to a nine-year high.

While a weak currency might provide short-term economic boost to the countries engaging in currency devaluation, this might take a toll on global trade and capital flow in the long term (read: Global Policy Easing Puts These ETFs in Focus).

A Look to International Easing Action

Several countries in recent months cut their interest rates or took other actions to boost growth in their economy. The first and foremost country is Japan, which unexpectedly expanded its bond buying plan to 80 trillion yen from 60–70 trillion yen per year and tripled the pace of purchasing stocks and property funds (REITs) in October. Further, the government of Japan recently approved a spending package of 3.5 trillion yen ($29.12 billion) to boost consumer spending and regional economic activity.

In November, the People's Bank of China surprised the global market with a cut in interest rate for the first time in more than two years. The central bank slashed the one-year lending rate by 40 bps to 5.6% and the deposit rate by 25 bps to 2.75%. Further, China's central bank lowered the reserve requirement ratio by 50 bps to 19.5%, effective February 5.

Other nations also followed suit this year. The Reserve Bank of India (RBI) cut interest rates by 25 bps to 7.75% first time in almost two years while Swiss Bank scrapped its three-year old currency cap against the euro, which was pegged at 1.20. Meanwhile, the Bank of Canada reduced interest rates by 0.25% to 0.75%, representing the first rate cut since April 2009 (read: India ETFs Surge After Surprise Rate Cut).

The Turkey central bank trimmed one-week repo rate by 50 bps to 7.75% while Peru reduced the benchmark interest rate by 25 bps to 3.25%. Egypt too lowered the deposit rates and lending rates by 50 bps to 8.75% and 9.75%, respectively. The Danish central bank cut its deposit rate thrice in two weeks to a negative 0.35% from a negative 0.20%.

The European Central Bank (ECB) launched a bond-buying program, committing to pump €1.14 trillion ($1.16 trillion) into the sagging Euro zone economy over the next one and half years. It plans to buy €60 billion of government bonds, debt securities issued by European institutions and private sector bonds per month through September 2016 (read: Europe ETFs in Focus after ECB and Swiss Action).

Singapore announced a surprise currency policy easing, wherein the Monetary Authority of Singapore reduced the slope of the appreciation of the Singapore dollar against a basket of currencies by a percentage point. The most recent move came from Reserve Bank of Australia, which lowered interest rates by 25 bps to a record low of 2.25%. This is the first rate cut in 18 months. Further, Russia slashed the one-week repo rate to 15% from 17%.

With that being said, the U.S. dollar is surging and other currencies are slumping. And investors need to be cautious when looking to invest outside the U.S. This is because a strong dollar could wipe out the gains when repatriated in U.S. dollar terms, pushing the international investment into red even if the stocks perform well in the rising-dollar scenario.
 

How to Play?

With the advent of the currency hedged ETFs, it has become easy for investors to cope with this situation. This is especially true as these funds look to strip out currency exposure to a foreign economy via the use of currency forwards or other instruments that bet against the non-dollar currency while at the same time offers exposure to the stocks of the specified nation.

While there are a number of ETFs targeting specific nations, we have highlighted three ETFs that provide broad international play or exposure to more than one country.

Deutsche X-trackers MSCI All World ex US Hedged Equity ETF ((DBAW - ETF report))

This fund offers exposure to the stocks in developed and emerging markets (excluding the U.S.) by tracking the MSCI ACWI ex USA US Dollar Hedged Index while at the same time provides hedge against any fall in the currencies of the specified nation. In total, the fund holds a broad basket of more than 1,300 securities with none holding more than 1.46% share. However, it is skewed towards the financial sector with 26.9%, followed by consumer staples (13.2%) and consumer discretionary (11.3%)

Among countries, Japan and United Kingdom take the top two spots with at least 14 share each while Switzerland, Germany and France round off the top five with single-digit exposure. The ETF has amassed $16.3 million in its asset base while trades in a light volume of 12,000 shares per day on average. Expense ratio came in at 0.40%. The fund is up 12.2% in the trailing one-year period (see: all the World ETFs here).

iShares Currency Hedged MSCI EAFE ETF ((HEFA - ETF report))

For a broad foreign market play without currency risks, investors could also consider HEFA which focuses on the EAFE region — Europe, Australasia, Far East — for exposure. This product follows the MSCI EAFE 100% Hedged to USD index and is basically a holding of EFA with currency hedged tacked on. Financials dominates the fund’s return with one-fourth share while consumer discretionary, industrials, consumer staples, and health care also get double-digit allocation.

Top nations include Japan, United Kingdom and Switzerland, while France and Germany round out the top five for this well-diversified fund. The fund has AUM of $391.2 million and average daily volume of roughly 162,000 shares. It charges 39 bps in annual fees and expenses and has added 11.6% since its debut almost a year ago.

Deutsche X-trackers MSCI Emerging Markets Hedged Equity ETF ((DBEM -ETF report))

This product tracks the MSCI EM US Dollar Hedged Index, which provides exposure to the emerging equity market and hedges their currencies to the U.S. dollar. The fund holds 460 securities in its basket, which is widely spread out across each component with none holding more than 3.86% of assets. Chinese firms takes the top spot at 22.5% while South Korea, Taiwan and Brazil round off the next three spots (read: China ETFs in Focus on Surprise Rate Cut).

From a sector look, financials accounts for the largest share at 28.6% closely followed by information technology (13.8%), telecom services (11.1%) and consumer staples (10.6%). The fund has managed $103.2 million in its asset base while trades in good average daily volume of around 162,000 shares. It charges 65 bps in fees per year and has returned 10.4% over the past one year.

Bottom Line

The popularity for currency hedging strategies has been on the rise on a strengthening U.S. dollar and the prospect of higher interest rates in the U.S. against lower interest rates in other countries. These products are expected to perform better than the traditional funds in the coming months thanks to the global currency war.