Written by: John Lewis, Senior Portfolio Manager at Dorsey, Wright & Associates (A Nasdaq Company)
If you’re headed to Europe this summer, chances are good you’re going to see a nice boost to your budget due to the exchange rate. The current strength of the dollar has certainly been great for US tourists, as well as US-based companies who source goods overseas. But it hasn’t been such a windfall for international companies or their investors. As an advisor, that can present a tough challenge. Your clients need the international exposure, but the strong dollar limits the opportunity for return. The media isn’t helping either, making your clients wary about non-US investments. With China’s economic woes just the tip of the iceberg, it’s no wonder international stocks been out of favor for years.
Despite the obstacles, international stocks are a vital part of a strong, diversified portfolio. But how do you persuade your clients to take the leap? And even if they do, what’s the best way to go about adding non-US assets to a portfolio when you’re working with smaller clients for whom mutual funds aren’t the best option?
One approach that has been delivering positive results for more than a decade is to leverage the “smart” in smart beta—focusing on momentum and trend—while adding ADRs to the mix to include international stocks with lower transaction fees. The benefits are twofold. First, not only does smart beta offer your clients an alternative to passive index investing, but because it focuses on momentum and trends, it’s a powerful approach that “lets the winners run” while weeding out stocks that are losing momentum or beginning their downward descent. This helps minimize the increased risk that many investors have learned to associate with non-US markets. Second, leveraging ADRs not only opens the door to foreign stocks by eliminating international transaction fees, but because they’re denominated in US dollars, they actually increase in value as the strength of the dollar wanes.
But the dollar is strong…right? At the moment, yes. But just as it’s wise to look at momentum and trends in stocks, taking a close look at how the dollar is trending is important as well. This past January, the dollar index hit its highest point in a decade. It’s precisely why you got online and booked that trip to Italy. But the tide appears to be turning. Last week the dollar index fell to its weakest level since January 2015, and indicators are pointing to potential continued weakness. Historically, a falling US dollar tends to have a negative impact on domestic returns and a positive impact on non-US returns.
It’s easy to see that if this downward trend continues, now is an ideal time to invest in the “winners” overseas. It may not be ideal when you’re paying your tab for dinner in Rome, but it may be just the environment you’re looking for in your client’s portfolio.
The great news is that this approach isn’t limited to institutional and other larger investors. By utilizing ADRs, it opens the door to smaller retail accounts that would otherwise be restricted to mutual funds or domestic momentum portfolios. Plus, as long as the product is backed by a strong, disciplined momentum methodology, it can effectively cut out the losers—those international stocks that are trending downward— while building on the strength of the winners that are trending upward or continuing their strong momentum. Whether the dollar trends up or down in the coming months, this approach is a valuable alternative. It offers your clients international exposure without some of the increase in risk that can send their emotions reeling or, even worse, dissuade them completely from taking on international exposure.
To learn more about Smart Beta ETFs and the Dorsey Wright Relative Strength strategies, download the whitepaper Point & Figure Relative Strength Signals or contact Dorsey Wright . You can also listen to the Dorsey Wright weekly podcast here .There are risks inherent in international investments, which may make such investments unsuitable for certain clients. These include, for example, economic, political, currency exchange, rate fluctuations, and limited availability of information on international securities. DWA, and its affiliates make no representation that the companies which issue securities which are the subject of their research reports are subject to, or in compliance with certain informational reporting requirements imposed by the Securities Exchange Act of 1934. The use of ADRs may be subject to foreign tax withholdings.
The relative strength strategy is not a guarantee. There may be times where all investments or asset classes are unfavorable and depreciate in value. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.
The information contained herein has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this material without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions.