Investing involves risk
Investing involves risk. The risk could be fewer returns than expected or even a loss of principle. Foreign investment involves greater and different kinds of risk than investing in domestic companies. These risks can include liquidity risk, less efficient trading markets, a lack of comprehensive company information, political instability, variations in audit and legal standards, and currency exchange rate fluctuations.
The upside and downside potential of currency volatility
Let’s start by understanding the upside and the downside risk of currency fluctuations. We’ll do this with the help of an example.
The exchange rates taken in the example below are random rates. Suppose the US company Nike (NKE) buys 100 stocks of Indian company Infosys (INFY) and 100 stocks of German company Deutsche Bank (DB) as an investment.
Assume that, a year later, the Indian currency depreciates by 25% and the German currency appreciates by 50% with no changes in stock values.
We can see that a 25% depreciation in the Indian rupee would reduce the investment value in the US dollar by 20%. A 50% appreciation in the German currency euro would increase the investment value in the US dollar by 100%.
The currency exposure of investing in foreign equities can significantly affect an investment’s performance. In order to reduce currency risk and benefit from potential growth opportunities globally, you can use hedged equity currency ETFs.
The WisdomTree Europe Hedged Equity ETF (HEDJ) and the Deutsche X-trackers MSCI Europe Hedged Equity ETF (DBEU) are two ETFs that help reduce the currency risk of investing in Europe. Similarly, the WisdomTree Japan Hedged Equity ETF (DXJ) and the Deutsche X-trackers MSCI Japan Hedged Equity ETF (DBJP) are good options for investors seeking to gain exposure to Japanese equity while protecting their investments from the downside risk of currency fluctuations.
In this series, we’ll take a look at how these funds have performed during volatile times. Let’s start in the next part with the European equity hedged funds.