Investors have largely embraced international ETFs to start
2013. Funds tracking emerging markets have seen particularly huge
inflows and are easily setting the pace for ETFs this year.
Yet while many investors may be jumping into these products,
some might not understand one of the biggest—and arguably most
important—aspects of these types of funds, currency exposure. While
this seemingly insignificant issue may be an afterthought for most,
it can actually be a huge driver, or even the main determinant, of
performance in a given time period.
That is because for American investors in foreign securities,
returns consist of two components; the performance of the
underlying stocks +/- the foreign currency impact.
Depending on how the dollar has traded, this forex aspect can
result in a big difference when returns are repatriated back to
dollars. If the dollar has strengthened against international
currencies, total returns will be lower, while the opposite will be
the case when the U.S. currency is facing global weakness (read
Currency Hedged ETFs: Top International Picks?).
This is especially true when investors look at countries which
have seen huge currency swings (relative to the dollar) in recent
trading. Two important markets where this has been true over the
past year are Brazil and Japan.
Brazil & the real
In the case of Brazil, many of its ETFs experienced a
rocky 2012 and largely finished the year in the negatives. In fact,
the nation’s most popular ETF, the iShares MSCI Brazil
Index Fund (EWZ) finished 2012 down about 4.6%, a huge
reversal of trends for the once-booming economy.
While this is a pretty disappointing figure, investors should
note that the Brazilian market was actually up on the year, if you
look at it in Brazilian real terms instead. The nation’s
currency lost about 5% against the dollar in 2012 so nearly all of
the loss last year for U.S. investors was thanks to Brazilian real
weakness (see Time to Worry about Brazil ETFs?).
Consider the chart below which shows EWZ and
BZF—representing the real—over the past year:
![](http://www.zacks.com/images/upload_dir/1360015771.jpg)
As you can see, both have moved in a narrow range
lower for much of the year. Additionally, without the sluggish real
dragging down EWZ’s performance, the past 12 months wouldn’t have
been nearly as bad, probably closer to half as bad in fact.
Even Worse in Japan
This problem has been even more apparent—but at least
avoidable—when looking at Japanese ETF investments over the past
few months.
In this time period, rumblings over a weak currency policy and
higher inflation thanks to the new Japanese Prime Minister have
pushed the yen to fresh lows. This has had a huge impact on
sentiment over Japan and has caused many to rethink investing in
the nation, although the results have been skewed due to the rapid
deterioration of the yen in the time frame.
In the past three months, the most popular Japan ETF,
EWJ, has added about 11%, largely thanks to this
booming confidence. However, in the same time period, the yen—as
represented by FXY-- has declined by about 13%
(read Play a Resurgent Japan with These Three ETFs).
So in yen terms, the broad Japanese market is up more than 20%
on the year. But when U.S. investors repatriate these assets into
dollars, thanks to the yen’s slump, roughly half of their gains
disappear for American buyers.
Fortunately, at least in Japan’s case, there is a liquid way to
avoid this situation with a currency-hedged ETF. This product, the
WisdomTree Japan Hedged Equity Index Fund (DXJ),
strips out the yen exposure, leaving investors with a pure play on
Japanese stocks.
When the yen is sliding and Japanese stocks are surging, this
can be a brilliant play, although if the yen strengthens investors
could lose out on some gains. However, yen strength obviously
hasn’t been the case as of late and it has made DXJ the top choice
for Japanese ETF investing by a pretty wide margin:
![](http://www.zacks.com/images/upload_dir/1360015780.jpg)
Bottom Line
Currency exposure matters, and it can add up in a hurry. Even a
correct call on a country can turn into a losing trade if the
foreign currency exposure doesn’t go your way.
So, either consider hedged or dollar-denominated products to
avoid this issue, or make sure you are bullish on a nation’s
currency as well. If not, you may be disappointed with the results
when looking at them in U.S. dollars, should the greenback continue
to strengthen against foreign currencies (see Three Biggest
Mistakes of ETF Investing).
Clearly, both a favorable forex impact and solid stock returns
are necessary for those seeking truly outstanding performances in
international ETFs. Just make sure that you consider this key
aspect the next time you are looking at an ETF, or even any
international stock, before you dive in.
Want the latest recommendations from Zacks Investment Research?
Today, you can download 7 Best Stocks for the Next 30
Days. Click to get this free report >>
Follow @Eric Dutram on Twitter
WISDMTR-BRZ RL (BZF): ETF Research Reports
WISDMTR-J HEF (DXJ): ETF Research Reports
ISHARS-JAPAN (EWJ): ETF Research Reports
ISHARS-BRAZIL (EWZ): ETF Research Reports
CRYSHS-JAP YEN (FXY): ETF Research Reports
To read this article on Zacks.com click here.
Zacks Investment Research
iShares MSCI Brazil ETF (AMEX:EWZ)
Historical Stock Chart
From Jul 2024 to Aug 2024
iShares MSCI Brazil ETF (AMEX:EWZ)
Historical Stock Chart
From Aug 2023 to Aug 2024