U.S. investors have poured money into single-country exchange traded funds with encouragement from Wall Street, but that can be a dangerous strategy. Such a strategy often leads to dangerous over concentrations, which, like leverage, can amplify both gains and losses. (See SmartMoney Magazine, “Wilting ETF Returns”).
Even if a country’s economy is humming along, its ETF fund can get “crushed.”. One reason for that has to do with currency exchange rates. If the foreign currency drops relative to the U.S. dollar, that erodes gains or increases losses being exchanged back into U.S. dollars. Predicting currency exchange rates “is more difficult than picking stocks,” according to one fund executive quoted in the article. But few such funds employ any type of hedging strategy that might reduce the currency exchange rate problem because fund managers say it would cost too much to do that.
Not surprisingly, professionals say the best way to guard against the risks of single-country exchange traded funds is to diversify. The most effective and efficient way to diversity is to buy broadly diversified index funds, not single-country funds.
Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.