If the recent trend continues, shareholders of international funds could see a little boost in performance from an unexpected source - the declining value of the dollar.
While the returns of international funds are driven primarily by the funds' investments, international funds that do not use currency hedges may see improved performance thanks to a weakening dollar in addition to appreciation in the value of their securities. When the dollar declines, investments in unhedged international funds increase in value because the investments are held in foreign currency rather than dollars.
Some funds now that do hedge and invest in countries such as Japan may be tempted to drop their hedging strategy because of the weakening dollar, said Gregg Wolper, international funds editor for Morningstar of Chicago, the fund rating firm. The dollar this month has fallen to a three-year low against the Japanese yen.
"In recent years, it has helped performance [to hedge]," Wolper said. "In previous years, it didn't."
One fund group is planning a switch from hedged to unhedged investing. The Worldwide Index Funds, a family of 13 primarily country-specific index funds, is asking shareholders to approve a change in the funds' investment objective which would eliminate the requirement that the funds try to reduce the effect of currency fluctuations. Worldwide described the proposal in a preliminary proxy statement that the funds filed with the SEC on Sept. 17. Shareholders are expected to vote on the plan at a meeting scheduled for Oct. 15.
The proposed change was not prompted by recent declines in the value of the dollar but based on a survey of clients and an analysis of long-term investment volatility, said Keith Pipes, managing director of LMI Capital Management LLC of Pasadena, Calif. LMI is adviser to the Worldwide funds.
LMI found that Worldwide shareholders largely were either indifferent to hedging or preferred that the funds not hedge the currency risk posed by investing abroad, Pipes said. Shareholders who preferred that the funds invest without a currency hedge viewed the unhedged approach as providing additional investment diversity, Pipes said. LMI's own research also suggested that unhedged funds reduced investment risk over the long term.
Hedging also made it difficult for Worldwide to compare its performance against that of its peers, Pipes said. While Worldwide has been hedging currency risk, the majority of international funds do not, Pipes said.
"We want to be more comparable to the competition," Pipes said.
Cost can also be a factor in deciding whether or not to hedge currency risk. In some markets, the expense of entering into derivative contracts makes hedging impractical. Matthews International Capital Management of San Francisco, adviser to the $400 million Matthews Funds, normally does not hedge currency risks in non-Japanese Asian markets in part because of the expense of hedging, said Paul Matthews, chief investment officer for the funds.
But, Matthews is flexible on the question of when to hedge. The firm hedges about 30 percent of its assets in the Matthews Japan Fund. The firm has made the move to reduce the fund's volatility, Matthews said. The cost of hedging against the yen also tends to be cheaper than it is for other Asian currencies, Matthews said.