One of the big stories this year has been the weakness in the U.S dollar after a strong run in the second half of 2016. A confluence of factors is affecting the euro—from politics in the U.S. to monetary policy shifts that may occur later this year in the eurozone.
This has caused a shift in the attention of investors, from a focus on currency-hedged strategies that have the goal of isolating the equity market returns alone to “double decker” strategies that add currency risk on top of the equity returns.
Strategically, I believe there is a case to hold hedged strategies over the long run to reduce the uncertainty that comes with currencies. Sure, the euro is on a hot streak at the moment—but this is far from a sure sign to add value always and forever as unhedged strategies dictate. The euro’s volatilityover the last 20 years has been 10%—and the average annual move in either direction plus or minus 9%.1
Is now the time to turn more tactically bullish on the euro?
The increased flows to unhedged European stock exposures mean—whether intentionally or unintentionally—investors are taking on more euro risk. Instead of always being long the euro on top of equities, for those who wish to add in currency risk, WisdomTree has been advocating a dynamic factor model to determine how much risk to hedge or keep exposed.
Our currency factor model uses three factors to determine the hedge ratio: interest rate differentials, value and momentum.
