US based investors with international portfolios might consider the merits of hedging as the US dollar appears to be entering a period of sustained strengthening, according to Mellon Capital Management, the San Francisco-based multi-asset-class investor for BNY Mellon.
Sam Valtenbergs, research analyst of Mellon Capital, said:"A long bullish run by the US dollar could detract significantly from the returns of international portfolios that are not hedged against the currency."
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Investors in exchange-traded funds (ETFs) might be surprised at the differences in returns from two separate ETFs, if one is hedged and the other is not, Valtenbergs said.
According to the report, since the beginning of May, the market has been focusing on the expected winding down of the US Federal Reserve’s quantitative easing program. Over that period, the dollar has been strengthening against its developed market peers and also the paper notes that emerging markets rates and currencies have had increased volatility.
Mellon Capital said investors had been expecting the combination of the US trade and budget deficits to continue to put downward pressure on the value of the US dollar, but the budget sequestration that became effective on March 1 has helped to rein in the US budget deficit.
The report said that while the current account remains in negative territory, it has been stable for years.
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By GlobalDataMellon Capital said if the current account and budget deficits demonstrate continuing improvement, the dollar could continue to strengthen.
Mellon Capital’s report said that the dollar is likely to outperform during periods of risk aversion and underperform during periods of heightened risk appetite. However, the currency could outperform over the longer term if the U.S. economy can continue to strengthen in a benign inflation environment.
Vassilis Dagioglu, head of asset allocation, portfolio management, Mellon Capital, said:"When one considers the relative inexpensiveness of hedging the currency risk of international portfolios against a rise in the U.S. dollar, it could prove to be good value for US based investors."
