Currency Hedging and Brexit

by: , Chief Investment Officer and Managing Director | IndexIQ

Brexit is the story that won’t go away. Every few weeks, it seems, it’s back in the headlines, most recently with the vote in England’s House of Commons to overwhelmingly reject the exit plan proposed by British Prime Minister Theresa May.

For investors, this drama plays out in multiple ways. There’s concern about what it means for the UK and European Union (EU) economies: there are global repercussions if growth slows. There’s the issue of EU unity broadly and the commitment of member countries to its long-term success. Less talked about but still important is how it’s unsettling currency relationships.  Both the Euro and the British Pound have bounced around in reaction to Brexit news in ways that have sometimes confounded the prognosticators. This up and down movement relative to one another – and to the dollar – in turn impacts the value of UK and EU investments for a U.S.-based investor.

Nearly all observers agree that a “hard” Brexit – one with no agreement on how to manage trade and other issues once Great Britain leaves the EU – is a recipe for disaster. But after that there’s not much in the way of consensus. When May first postponed the vote on the 585-page Brexit agreement last December, the Pound fell to a 20-month low, declining 1.6% against the dollar and 1.5% against the Euro. When the Brexit deal was voted down a month later, the Pound rallied and it rallied again when May survived a “no confidence” vote. Go figure.

So, while there are fundamental economic issues at stake, for the moment a lot of the currency movement is driven by the politics. Traders might welcome this volatility, but for long-term investors it’s mostly a distraction. Trying to fully hedge in this kind of market can be expensive and frustrating as unanticipated plot turns cause values to spike up and down based on little more than rumors and speculation. This brings us back to a familiar position: advocating for the currency hedge “of least regret” – 50 percent – as a way to dampen volatility without taking a stand on the direction of returns. This is even more important in times like these, when unusually high turbulence can cause investors to second guess their long-term strategies.

The Brexit show will continue to roll on for a while. The “drop dead” date for withdrawing is set as March 29th, though that could still be extended. Depending on the direction of the debate, the market for the Pound could continue to see significant swings up to that date and, probably beyond, as the two economies adjust to the shifting circumstances. Even for UK residents, the twists and turns of all this are hard to follow and the ultimate resolution impossible to predict. (Though the possibility is remote, there could even be a second referendum on withdrawing.)

For those outside the UK and the Eurozone who want to maintain exposure to those equity markets, it’s good to have an investment option that allows you to remove yourself from the debate and stay committed to the plan. That, we would argue, is one of the benefits of HFXI, a core internationally developed ETF with a 50 percent currency hedge that never has to be lifted or adjusted.

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Salvatore J. Bruno

Chief Investment Officer and Managing Director | IndexIQ

Sal is Chief Investment Officer at IndexIQ, where his primary responsibility includes developing and maintaining the firm’s investment strategies. Sal joined IndexIQ in 2007 from Deutsche Asset Management (DeAM) where he held a number of senior positions

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