The
ECB
has
cut
rates,
but
the
US
Federal
Reserve
is
looking
unlikely
to
follow
suit,
potentially
paving
the
way
for
a
weaker
euro.

For
investors
in
foreign
currency-denominated
assets,
this
could
mean
improved
returns
as
currency
effects
boost
the
overall
performance
of
their
investments.
In
the
longer
term,
improved
competitiveness
of
export
goods
may
also
boost
shares
of
companies
in
the
Eurozone.

“We
expect
the
dollar
to
remain
strong
in
the
face
of
faster
ECB
easing
and
the
role
of
the
dollar
as
a
high-yielder,”
Deutsche
Bank
strategists
wrote
on
Friday.

From
mid-April
to
early
June,
the
euro
had
strengthened
slightly
against
the
US
dollar,
rising
to
1.08
from
1.06.
Now,
however,
diverging
positions
of
the
Federal
Reserve
and
the
ECB
will
have
to
be
reckoned
with.
As
the
Fed
is
in
no
hurry
to
cut
rates,
monetary
policy
divergence
between
the
US
and
Europe
is
likely
to
increase.

“The
effect
of
asynchronous
cuts
by
the
ECB
or
BoE
would
likely
lead
to
a
sharp
depreciation
of
the
euro
or
pound
against
the
US
dollar
and
other
major
currencies,”
Morgane
Delledonne,
head
of
investment
strategy
in
Europe
at
Global
X,
wrote
in
a
note. “This
would
be
counterproductive
for
containing
inflation
in
Europe,
as
it
would
make
imports
more
expensive,
but
would
certainly
improve
competitiveness
and
stimulate
exports.
In
this
scenario,
European
equities
could
offer
investors
attractive
entry
points
compared
to
their
US
counterparts.”

How
currency
fluctuations
affect
asset
values

If
a
foreign
currency
appreciates
against
the
local
currency,
the
effect
will
be
positive
for
foreign
assets,
conversely,
if
the
local
currency
were
to
strengthen,
this
alone
would
have
a
negative
effect
on
foreign
assets.

For
example,
the
Morningstar
US
Market
Index
gained
10.5%
since
the
start
of
the
year
in
US
dollar
terms,
while
the
euro
version
managed
to
climb
as
much
as
12.4%,
thanks
to
a
favourable
trend
of
the
dollar
appreciating
against
the
euro.
Following
the
same
dynamic,
the
Morningstar
Eurozone
index
has
risen
11.5%
in
euro
terms
year-to-date,
while
its
US
dollar
counterpart
has
risen
only
9.6%
over
the
same
period.

To
take
an
inverse
example
where
the
euro
gained
against
a
foreign
currency,
the
Morningstar
Japan
Index
rose
7.9%
in
euro
terms
this
year,
while
the
yen
version
of
the
same
benchmark
did
much
better,
gaining
16.5%
as
of
writing.
That’s
because
the
value
of
the
euro
against
the
Japanese
yen
increased
by
almost
10%
over
the
period.

In
this
case,
Japanese
investors
holding
euro-denominated
assets
benefited
from
the
euro’s
strength,
while
Eurozone
investors
holding
Japanese
assets
would
have
been
wise
to
hedge
against
the
exchange
rate
risk
with
a
suitable
instrument.

How
to
hedge
against
currency
risk

For
those
who
want
to
avoid
having
to
think
about
currency
movements,
an
increasing
number
of
mutual
funds
and
ETFs
offer
a
hedged
share
class,
which
aims
to
neutralise
the
currency
risk
on
final
returns
as
much
as
possible.
In
the
table
below
are
the
different
performances
of
three
different
versions
of
the
Invesco
ETF
tracking
the
S&P
500
from
2020
to
the
present.

In
most
cases,
currency
hedging
is
used
by
professional
investors
who
have
a
particular
view
on
the
development
of
a
currency
or
who
need
to
balance
their
portfolio.

They
are
also
often
used
by
bond
investors
who
want
exposure
to
a
particular
country’s
debt
but
also
want
to
reduce
the
currency
risk
as
much
as
possible. This
is
particularly
the
case
when
investing
in
emerging
market
debt,
where
countries
like
Argentina
and
Turkey
have
suffered
currency
crises
but
investors
still
sought
opportunities
in
their
higher-yielding
bonds.

Is
currency
hedging
really
worth
it?

The
primary
benefit
of
hedging
is
a
significant
reduction
in
currency
risk.
However,
hedging
is
never
perfect,
and
as
the
table
above
shows
that
hedged
and
foreign-currency
performance
can
deviate.
That’s
partly
because
there
is
always
a
higher
commission
to
pay.

Most
such
funds
use
forward
contracts
to
hedge
currency
risk.
These
contracts

which
simply
lock
in
a
future
exchange
rate–
are
subject
to
the
“rolling
effect”.
Futures
contracts
must
periodically
be
replaced
at
maturity,
and
this
generates
the
“roll
yield”.
Such
yield

which
can
be
positive
or
negative

is
determined
by
the
difference
between
the
price
of
the
rolling
near-term
expiring
contract
and
the
price
of
the
new
forward
contract
with
an
expiration
date
further
in
the
future.

Investors
should
also
be
mindful
of
their
investing
horizon.
“Returns
attributable
to
foreign
exchange
rates
can
ebb
and
flow
over
time
and
add
to
an
investment’s
volatility,
but
they
tend
to
have
a
muted
impact
on
long-term
rates
of
return”,
explains
Daniel
Sotiroff,
senior
manager
research
analyst
at
Morningstar.
“Meanwhile,
the
impact
of
exchange
rates
on
returns
can
be
quite
dramatic
over
short
periods
of
time.”

For
most
retail
investors,
the
unhedged
option
usually
remains
the
easiest
solution,
especially
in
the
case
of
global
funds
where
there
are
many
underlying
currencies
potentially
moving
in
different
directions.

 

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