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Tapping Model Portfolios to Mitigate Currency Risk

With the dollar weakening, hedging risk may not be the top priority for many advisors, but that doesn’t mean that risk is off the table.

The right strategies, such as the Developed International Model Portfolio, which is part of WisdomTree’s Modern Alpha lineup of model portfolios, can help advisors properly position equity sleeves for clients seeking reduced currency risk.

“This model portfolio is designed for investors with a long-term horizon looking for exposure to a broad universe of Developed International equities primarily using factor focused ETFs,” according to WisdomTree. “The selected ETFs provide certain factor tilts that have the potential to generate excess return relative to comparable cap-weighted benchmarks over longer-term holding periods. The strategies may use both WisdomTree and non-WisdomTree ETFs.”

Historical data confirm ignoring currency fluctuations introduces another layer of risk to portfolios.

“The reality is that unhedged international strategies carry a second layer of risk and exposure courtesy of foreign exchange fluctuations,” said WisdomTree Global Head of Research Jeremy Schwartz in a recent note. “By not hedging currency risk, you are implicitly making a bet on an underlying currency, whether you realize it or not. Currency-hedged strategies have the goal of isolating returns to stock performance in their local markets, with no additional risk or movement from directional changes in local currencies. That is what most stock investors want in the first place, even if they don’t realize it.”

Hedging Benefits

A fully hedged portfolio position has historically diminished returns when the U.S. dollar depreciated or international currencies strengthened. Since a hedged portfolio shorts foreign currencies, investors would miss out on the added boost if international currencies appreciated.

“By utilizing unhedged strategies, most investors inherently express bearish views on the dollar in perpetuity since the source of returns from their unhedged international strategy is attributed to stock and currency performance. That may not be their intention, but that is what they’re getting,” notes Schwartz.

One idea for asset allocators seeking the protection of a currency hedge is the WisdomTree International Hedged Quality Dividend Growth Fund (NYSEArca: IHDG).

IHDG targets dividend growers in developed markets, excluding the U.S. and Canada and features a currency hedge that can protect investors in the event the dollar rebounds around developed market currencies. IHDG, which carries an annual expense ratio of 0.58%, tracks the WisdomTree International Hedged Dividend Growth Index (WTIDGH)

Proving that hedging can work to investors’ benefit, IHDG is modestly higher this while the unhedged MSCI EAFE Index is off 9.16%.

For more on how to implement model portfolios, visit our Model Portfolio Channel.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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