Currency Effects on International Equity Returns

November 20, 2014 | Jesus Jimenez, Partner

One of the most significant challenges that international equity investors have faced this year is the impact of a stronger dollar. From many perspectives, a stronger dollar signals improved economic growth in the U.S. Unfortunately, a stronger dollar also acts as a headwind for U.S.-based investors purchasing international equities. In some instances, the impact of the stronger dollar has flipped positive returns denominated in local currency to negative returns when translated to U.S. dollars. In fact, this phenomenon has occurred year to date in 2014: the local currency return for a primary international equity index (MSCI EAFE) is positive (red bar; 4.2%), but becomes negative when denominated in dollars (blue bar; -2.4%).

In our Chart of the Week, we examine the retrospective returns of the MSCI index, denominated in both local currency and U.S. dollars. Based on the chart, two conclusions seem straightforward:

• The “winner” each year will vary over time, which is not surprising since the U.S. dollar strengthens in some years and weakens in others.
• Over the long term, the relative strengthening or weakening of the U.S. dollar is more or less balanced out, as the cumulative returns of each index – local and dollar – suggest, shown by the convergence of the two cumulative return streams.

If nothing else, this week’s chart should provide some comfort to investors whose returns have been negatively impacted by a stronger dollar: although the dollar acted as a drag on international returns this year, it is highly unlikely this will be a consistent pattern in the coming years, and should certainly not serve as a worry for long-term international equity investors.