Global monetary policy has increased volatility in foreign exchange markets in recent months. As a result, ETF, which invests in foreign stocks and bonds and uses currency hedging strategies, generally performs better than similar funds that do not use currency hedging.

Although over the past five years, such products that use hedging to protect funds have gone unnoticed by the market. But recently, as the dollar continues to rise, almost every ETF has outperformed other products.

As of Sept. 30, inflows into currency hedging ETF actually decreased by nearly $6 billion compared with the same period in 2021, according to Morningstar. The net worth of currency hedging ETF now totals $63.7 billion.

Todd Rosenbluth, head of research at VettaFi, an ETF data and analysis firm, said: "the average investor either doesn't understand these ETF or how they use these investment tools to guarantee returns. "

Rosenbluth addedCurrency hedging ETFETF can protect against the risk of the appreciation of the dollar, not the depreciation of the dollar.This is because a stronger dollar lowers investor returns when investing in foreign stocks and bonds, while a weaker dollar increases returns. The purpose of currency hedging ETF is to limit risk, not return.

Aniket Ullal, director of data and analysis at CFRA ETF, said:

All the signs are that the dollar will remain strong at the end of the year, driven by the Fed's rate hike and the performance of the US economy relative to other markets. This makes currency hedging ETF worth considering. "

Currency hedging against the sharp fluctuations in the yen and euro against the dollar has proved to be a good choice for investors this year. According to CFRA, the best-performing ETF for currency hedging so far this year is$Wisdomtree Japan Hedged Smallcap (DXJS.US)$(WisdomTree Japan Hedged Small Cap Equity ETF) this is a dollar fund that invests in Japanese small-cap stocks. It is up 2.86% this year through Sept. 30.

It is closely followed by$Wisdomtree Japan Hedged Equity Fund (DXJ.US)$The $1.9 billion fund, which invests in the Japanese stock market, is up 1.4 per cent so far this year.

$Ishares Currency Hedged Msci United Kingdom Etf (HEWU.US)$(iShares currency hedging MSCI UK ETF) invests in UK large-cap and mid-cap stocks and uses currencies to forward hedge gains and losses on sterling movements. By 2022, the fund had fallen 1.58 per cent, but its one-year return was 3.68 per cent.

How currency hedging ETF works

The way these ETF protect investors from currency fluctuations is simple.

They usually buy foreign exchange forwards (essentially currency contracts)-covering the value of the fund's total assets at the time of purchase. Forward exchange allows fund managers to lock in currency prices at a future date so that foreign exchange investment returns are not reduced when remitted in US dollars.There are two types of them: single currency hedge ETF and multi-currency hedge ETF.

The purpose of this is to offset currency risk, but there is also a caveat. For example, if the dollar strengthens-reducing the value of the fund's overseas investments-the gains on forward contracts should be sufficient to offset losses. But if the dollar weakens, forward contracts lose money, reducing investors' returns without hedging.

$Vanguard Total International Bo (BNDX.US)$(Vanguard Total International Bond Fund) is the largest currency hedging ETF with assets of $43.8 billion. The index fund invests in investment-grade bonds denominated in foreign currencies and involves a range of fixed-income securities, including sovereign and corporate bonds.

Jeff Johnson, head of fixed income products at Vanguard, said the $57 trillion international bond market was closely related to currency movements, and volatility in the money market could erode returns.

He said:

"that's why currency hedging is so important to bondholders, allowing them to diversify their asset classes. "

The cost of currency hedging has been falling for years, so the industry's ETF fee ratio is competitive. According to CFRA, 2/3 of US-listed currencies hedge ETF at a fee ratio of 0.5 per cent or less, allowing investors to use this method at a relatively low cost. Some are even the lowest cost. For example, the cost ratio for BNDX is only 0.07%.

Screening criteria worthy of attention

When evaluating such currency hedging ETF, investors should pay attention to:

In response, Johnson said:

In the face of the global macroeconomic environment, investors allocate part of their portfolios in international stocks and bonds is a good way to manage risk.

Many people have some biases in their investments. But simply investing all your money in domestic assets carries its own risks-especially when the US market is in trouble. Currency hedging is a strategy worth considering when making overseas investments in an environment of appreciation of the US dollar.