by Ben Claremon | Research Analyst
As of the huge currency moves the world has witnessed over the last year or so, the topic of currency hedging has recently become very pertinent to both investors and companies who generate sales overseas. For anyone who has not been paying close attention to the how much the dollar has strengthened, here are a couple of eye-opening data points.
- The Euro/US Dollar rate closed at 1.07 on April 20th 2015, down from 1.38 in April of 2014—a 22.4% decline
- The Yen/US Dollar rate closed at .0084 on April 20th 2015, down from 0.0097 in April of 2014—a 15.5% decline
Aside from making it much more attractive for Americans to travel to Europe and Japan, such large currency moves have significant impacts on US-based companies that have substantial sales abroad. Specifically, it is not uncommon to see companies forecasting revenues to be down 20% or more in their European divisions. Unsurprisingly, the term “constant currency” is showing up much more in press releases and on conference calls. In other words, companies are trying to get people to focus on what sales would have been if the currency had not declined as dramatically.
What matters more to us is whether actually business is being lost to non-US competitors as a result from an immediate pricing improvement and we would argue that the answer is yes, as no human or machine can adjust effective pricing that quickly and for that large of a move.
The second and really more interesting thing is whether a US-based investor should hedge currency when he purchases a non-US security. After all, we would consider ourselves relative geniuses on the company and the value, not per se the macro currency trade, so why not hedge out the currency and let our genius prevail unobstructed by pithy macro trends? To help answer that, we turn to our quant friends at GMO for an answer. The conclusion may surprise you, and may cause you to think twice about the logic of investing in currency-hedged ETFs.
