International/ Global Equity The mighty U.S. dollar Why investors may consider rethinking international allocations When left unhedged, currency exposure can have potentially negative effects on both the risks and returns of an investor’s international portfolio. With Deutsche Bank forecasting the U.S. dollar to appreciate against other major currencies through 2018, U.S. investors with international allocations may continue to see their returns eroded in the near term and overall risk elevated in the long run, all due to the currency effect. Confront your currency risk Since 1992, foreign currency exposure within international equity allocations has added to overall risk and affected returns. Currency-hedged investments seek to minimize both exposure to currency fluctuations and the potential for additional portfolio risk. Average annual returns Standard deviation (12/31/92–3/31/17) (12/31/92–3/31/17) 55 bps 20.92% 6.55% 180 bps 6.00% 19.12% Minimizing currency exposure led to …and a 9% reduction a 9% increase in volatility. in total returns… Hedged Difference Unhedged Hedged Difference Unhedged Source: Morningstar as of 3/31/17. Past performance is no guarantee of future results. It is not possible to invest directly in an index. Unhedged developed international equities represented by MSCI EAFE Index. Hedged developed international equities represented by MSCI EAFE U.S. Dollar Hedged Index. Standard deviation is often used to represent the volatility of an investment. It depicts how widely an investment’s returns vary from the investment’s average return over a certain period. Bps is basis points; one basis point equals 1/100 of a percentage point. Currency shifts have already begun chipping away at returns Currency effects on international returns can be significant Over the past few years, investors have felt the pain of negative currency movements. In fact, most hedged indexes have outperformed their unhedged counterparts over the past one-, three-, five- and 10-year periods. Investors solely targeting exposure to international equities, without the added currency factor, may want to consider a currency-hedged approach. Hedged index returns have outpaced their unhedged counterparts (annualized returns as of 3/31/17) 1-year 3-year 5-year 10-year Hedged Unhedged Hedged Unhedged Hedged Unhedged Hedged Unhedged Index return return return return return return return return MSCI EAFE Index 18.91% 11.67% 7.43% 0.50% 10.82% 5.83% 2.73% 1.05% MSCI Europe Index 21.04% 9.76% 7.48% –1.51% 10.76% 5.63% 3.72% 0.70% MSCI EMU IMI Index 21.44% 12.29% 8.35% –0.86% 12.55% 7.09% 2.93% — MSCI ACWI ex-USA Index 17.36% 13.13% 6.27% 0.56% 8.57% 4.36% 2.73% 1.35% Source: Morningstar as of 3/31/17. Past performance is no guarantee of future results. Performance for other time periods may not have been as favorable. Index returns do not include dividend distributions and do not reflect fees or expenses. It is not possible to invest directly in an index. See page 6 for index definitions. Hedged indexes are designed to mitigate the exposure to fluctuations between the value of the U.S. dollar and non-U.S. currencies, potentially allowing for purer exposure to international equity markets. Trends of the U.S. dollar Historical U.S. dollar cycles last an average of six to 10 years. Rather than attempting to time bull and bear U.S. dollar trends, investors seeking pure international equity exposure may want to minimize exposure to foreign currencies. U.S. Dollar Index (2/28/73–3/31/17) 175 5 years 7 years 10 years 7 years 10 years6 yrs. +101% 150 125 +50% +36% 100 75 –18% –51% –39% 50 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2017 U.S. Dollar Index (DXY) historical performance Current level Source: Bloomberg as of 3/31/17. Past performance is no guarantee of future results. For illustrative purposes only. The U.S. Dollar Index measures the foreign exchange value of the U.S. dollar compared to the euro, Japanese yen, Canadian dollar, British pound, Swedish krona and Swiss franc. Cycle end percentages represent cumulative USD index performance changes. The mighty U.S. dollar 2 Hedging currency has often lowered overall risk with minimal costs to hedging With the same equity exposure and international equity diversification benefits as their unhedged counterparts, currency-hedged strategies have not only produced higher returns over the long term, but have historically offered lower risk. Five-year standard deviation, hedged vs. unhedged indexes (4/1/12–3/31/17) 16.89% 15.33% 14.37% 14.86% 13.21% 12.93% 11.06% 11.18% 10.46% olatility 9.95% V MSCI MSCI MSCI Emerging MSCI MSCI Germany Europe Index EAFE Index Markets Index ACWI ex-USA Index Hedged Unhedged Source: Morningstar as of 3/31/17. See page 6 for index definitions. Volatility represented by standard deviation. The cost of hedging is largely driven by interest-rate differentials: If U.S. dollar rates are higher than those of the foreign currency being shorted, investors earn the difference between the two rates. If U.S. dollar rates are lower, investors pay the difference. Due to near-zero interest rates internationally, investors are currently paid to hedge many developed market currencies. Estimated annualized cost of carry for various currencies 2.05% 1.62% 1.46% 0.44% Cost to hedge 0.85% 0.38% –0.64% Paid to hedge Swiss franc Euro Japanese yen British pound Korean Norwegian Australian won krone dollar Source: Deutsche Asset Management, Bloomberg as of 3/31/17. The cost of currency hedging can be calculated using the “forward exchange (FX) rate” of a currency forward contract, which is primarily determined by the current FX spot exchange rate and the interest-rate differential between two currencies. The mighty U.S. dollar 3 The future impact of currency risk may be significant U.S. dollar positioned for dominance over the coming years Deutsche Bank remains one of the top leaders in Foreign Exchange (FX). We seek to harness these global strengths and resources from across the bank to deliver thoughtful and innovative investment opportunities. Our currency forecasts indicate that the current U.S. dollar strength may continue. Deutsche Bank forecasts significant U.S. dollar strength against most G10 currencies Spot Q2 % change Q3 % change Q4 % change % change USD-rates price 2017 vs. USD 2017 vs. USD 2017 vs. USD 2018 vs. USD EUR/USD 1.05 1.00 –4.8% 0.98 –6.7% 0.95 –9.5% 1.00 –4.8% USD/JPY 114 119 –4.2% 122 –6.6% 125 –8.8% 115 –0.9% GBP/USD 1.23 1.14 –7.3% 1.09 –11.4% 1.06 –13.8% 1.18 –4.1% USD/CHF 1.01 1.04 –2.9% 1.02 –1.0% 1.05 –3.8% 1.05 –3.8% AUD/USD 0.76 0.74 –2.6% 0.72 –5.3% 0.68 –10.5% 0.65 –14.5% NZD/USD 0.71 0.70 –1.4% 0.70 –1.4% 0.68 –4.2% 0.65 –8.5% USD/CAD 1.34 1.38 –2.9% 1.39 –3.6% 1.40 –4.3% 1.30 3.10% USD/SEK 9.08 9.39 –3.3% 9.51 –4.5% 9.74 –6.8% 8.75 3.80% USD/NOK 8.48 8.90 –4.7% 8.98 –5.6% 8.95 –5.3% 8.00 6.00% Source: Deutsche Bank as of 3/6/17. EUR=euro; JPY=Japanese yen; GBP=British pound; CHF=Swiss franc; AUD=Australian dollar; NZD=New Zealand dollar; CAD=Canadian dollar; SEK=Swedish krona; NOK=Norwegian krone; USD=U.S. dollar. To ensure calculation of foreign currency depreciation across all currencies, all percent changes vs. USD are based on crosses reflected in terms of foreign currency-over-USD rates. Currency forecasts point to potentially significant declines in international returns If currency forecasts are realized, the impact on international returns could be sizable. The U.S. dollar is expected to strengthen vs. multiple major currencies through 2018, potentially resulting in double-digit declines across a variety of international indices. The chart below shows a breakdown of the potential impact on unhedged index returns based on Deutsche Bank’s currency forecasts through 2018 and the weight of each currency within the respective index. Future currency impact potential –3.7% –3.8% –0.9% –4.8% –4.1% –6.5% –2.4% –8.9% –9.5% –8.8% –9.5% –13.8% MSCI EAFE MSCI Europe MSCI Japan MSCI Germany MSCI U.K. MSCI All World ex-USA 2017 2018 Source: MSCI and Deutsche Bank. The potential impact on unhedged index returns is based on 1) Deutsche Bank’s available currency forecasts through 2018 as of 3/6/17 and 2) the currency weighting, where applicable, for the euro, British pound, Japanese yen, Australian dollar, New Zealand dollar, Canadian dollar, Swedish krona, Norwegian krone and Swiss franc within each MSCI index, as of 3/31/17. See page 6 for index definitions. Assumes no cost of carry or cost of trading. For illustrative purposes only. Values based only on currency moves and do not incorporate gains or losses associated with equity movements. Opinions, estimates and projections in this report constitute the current judgment of the author as of the date of this report and are subject to change. The mighty U.S. dollar 4 Deutsche international equity currency-hedged strategies — #2 in overall FX1 — Best bank for FX spot2 Using our bank-wide FX expertise, Deutsche Asset Management delivers a variety of currency-hedged strategies designed to best suit our investors’ needs.