Don’t Compound a Weak Dollar Bet

We recently wrote about the rising correlations between stocks and bonds, as well as the increasingly negative correlation between the U.S. dollar and stocks.  

To rephrase the negative correlation between the U.S. dollar and the S&P 500, an investment in U.S. equities is, in part, a bet against a strong dollar. 

For global asset allocators, this raises an important question: Why double down on a weak dollar exposure in U.S. equities when investing internationally?

In our view, currency-hedged positions should be considered more as a default and strategic allocation that is neutral on the dollar’s direction, while unhedged investments compound an existing weak dollar bet investors already have within U.S. equities.  

No Diversification from Being Unhedged

One of the most common arguments we hear in favor of unhedged international allocations is that there are diversification benefits from currency exposure. 

The data does not support this greater diversification theory.  

The correlation between U.S. dollar investments in the EAFE (Europe, Australasia and Far East) region (representative of unhedged) and local currency EAFE investments (representative of hedged) with respect to the S&P 500 is an identical 0.80. In other words, there is no significant diversification effect from having currency exposure.

Looking at the right-most column, we observe the correlations of each index with U.S. dollar returns. 

• The S&P 500 and the Russell 2000 exhibit correlations of -0.43 and -0.41, respectively. This shows the weak dollar bias of core U.S. equities exposures, even in small caps that have lower overseas earnings.

• The MSCI EAFE (USD) shows an even greater weak dollar bet during this period, with a -0.61 correlation to the dollar.

• The MSCI EAFE (Local) also has a negative correlation to the dollar, but its correlation of -0.29 is only half that of the MSCI EAFE (USD)

In summary, we believe that investing internationally without the currency hedge compounds the existing weak dollar bet that investors already have with their U.S. equities exposure. 

Correlation Matrix: 12/31/08–12/31/23

Over the long-run, returns are similar between the MSCI EAFE Index in USD and local currency—justifying the belief among many investors that currency returns are a wash over time.

Though returns are similar, we see higher volatility in every standard period from being unhedged, with the incremental volatility from FX increasing to more than 5% in the most recent three-year period.  

Index Standard Deviation

For investors considering a currency-hedged allocation for international exposure, the WisdomTree International Hedged Quality Dividend Growth Fund (IHDG) has nearly 10 years of live track record.

The Fund has outperformed both the MSCI EAFE (USD) and MSCI EAFE (Local) indexes since its inception, doing so with 3% lower volatility than the MSCI EAFE (USD). 

Performance as of 1/31/24

For the most recent month-end and standardized performances and to download the Fund prospectus, click here.