Dollar diversification: 5 places to look beyond US equities

For much of the past decade, owning US equities delivered investors two powerful tailwinds: US market outperformance and, for many international investors, a strong US dollar.

That combination may be becoming less reliable, and the case for dollar diversification is becoming more structural than cyclical.

US debt is above USD40 trillion, fiscal deficits remain large and interest costs are rising. That does not imply a dollar collapse, but it does raise the longer-term risk of gradual currency debasement and weaker real purchasing power if inflation stays higher and policymakers tolerate stronger nominal growth to manage the debt burden.

At the same time, reserve managers are gradually diversifying into assets such as gold, while many investors already have heavy exposure to US equities, US bonds and the dollar.

The point is not to call the end of dollar dominance. It is to reduce dependence on one currency, one market and one policy regime.

This does not mean investors need to abandon US equities. But after years of US market leadership, many portfolios may have accumulated significant exposure to both US stocks and the US dollar.

Diversification therefore increasingly means thinking about currency as well as geography.

Here are five places investors could look.

1. Australia: commodities plus a stronger AUD

Australia may offer one of the more interesting combinations of currency and equity diversification.

The Australian dollar can benefit from a softer US dollar, relatively high Australian interest rates and strength in commodities. Copper has just reached a record of around USD14,700 a tonne amid tight global supply, adding another potential tailwind for Australia's resources sector.

For equity investors, this points towards miners such as BHP and Rio Tinto, which offer exposure to commodities including iron ore and copper and have very different earnings drivers from the technology-heavy US market.

Broad Australian equity ETFs offer another route for investors who do not want to select individual companies.

What to watch: A sharp slowdown in China, falling commodity prices or a dovish shift from the Reserve Bank of Australia could weaken both the AUD and Australian equity story.

2. Japan: favour domestic beneficiaries over exporters

The Japanese yen has staged one of the sharpest currency reversals this year, recently reaching a seven-month high as investors price faster Bank of Japan tightening and unwind yen-funded carry trades. Markets are heavily pricing a 25-basis-point BOJ hike next week.

But investors need to be selective.

A stronger yen is not automatically positive for every Japanese stock. Large exporters can see overseas earnings worth less when translated back into yen and may lose some international competitiveness.

Instead, investors looking for exposure to Japanese normalisation could consider more domestically oriented businesses. Banks such as Mitsubishi UFJ Financial Group and Sumitomo Mitsui Financial Group are worth screening because higher domestic interest rates can potentially support lending margins.

A broad Japan ETF provides another option, although investors should pay particular attention to whether the fund hedges its currency exposure. An unhedged fund provides exposure to both Japanese equities and movements in the yen.

What to watch: The yen has already moved quickly. If the BOJ delivers less tightening than markets expect, some of the recent currency rally could reverse.

3. Singapore: home-currency assets and income

For Singapore-based investors, diversification does not necessarily have to mean going further overseas.

Investors whose future spending is primarily in SGD but whose portfolios are heavily invested in US assets have a natural currency mismatch. Adding SGD-denominated assets can help balance that exposure while providing access to sectors that are relatively underrepresented in US indices.

DBS provides exposure to Singapore and regional banking, while Singapore Exchange offers a different financial-market earnings stream. Singapore's REIT market can also provide income exposure, although higher global bond yields remain an important risk.

Investors who prefer broader exposure can consider Singapore equity or dividend ETFs rather than selecting individual companies.

The important point is not that SGD assets will necessarily outperform US equities. It is that home-currency assets can play a different role in a Singapore investor's portfolio, particularly when future liabilities are also in SGD.

4. Europe: different sectors, different currency

European equities can provide diversification on two levels.

First is currency: unhedged European investments provide EUR exposure rather than USD exposure.

Second, and arguably more important, is the composition of the equity market. Europe offers relatively greater exposure to financials, industrials, healthcare and luxury goods, compared with the technology-heavy US market.

Stocks worth screening could include Allianz for financials and income, Siemens for industrial and infrastructure exposure, and SAP for investors who still want technology exposure without adding another US mega-cap.

Broad European ETFs may be the cleaner option for investors seeking diversification rather than a company-specific view.

The macro backdrop is also changing. The ECB is widely expected to raise interest rates by 25 basis points this week as renewed inflation pressures complicate monetary policy.

What to watch: European growth remains less dynamic than the US, while fiscal and political risks can periodically weigh on both European equities and the euro.

5. UK: income and value outside the US growth trade

The UK offers another very different equity-market mix.

The FTSE 100 has relatively large exposure to financials, energy, healthcare and consumer staples, while offering significantly less exposure to expensive technology stocks.

Companies such as HSBC can provide financial and Asian economic exposure, while Unilever offers defensive global consumer exposure. For investors focused on income, a broad UK or UK dividend ETF may be more useful than trying to select individual stocks.

Sterling exposure provides another source of currency diversification, although the UK's high inflation and fiscal challenges mean GBP is not a low-risk alternative to the dollar. UK long-term government borrowing costs have recently climbed to their highest levels since comparable records began in 1998.

What to watch: Fiscal concerns, weak growth and persistent inflation remain important risks for UK assets.

Stocks or ETFs?

There are two different ways investors can approach dollar diversification.

ETFs can make sense when the objective is portfolio diversification. A broad Australia, Japan, Europe, Singapore or UK ETF spreads company-specific risk while giving investors exposure to another market and, if unhedged, another currency.

Individual stocks can make sense when investors have a stronger sector or company view. Australian miners, Japanese banks or European financials, for example, may offer more targeted exposure to the underlying macro theme.

Investors should also check whether an international ETF is currency hedged or unhedged. Currency hedging was valuable when the dollar was strengthening because it reduced the drag from weaker foreign currencies. If the dollar enters a sustained weaker phase, however, unhedged international exposure can potentially add to returns.

Risks to the view

The dollar could still remain stronger for longer.

US productivity and AI-led growth could sustain capital inflows, higher real yields could keep dollar assets attractive, and the USD remains the world's dominant reserve currency and a key safe haven during market stress.

Fiscal challenges are also not uniquely American, so moving away from USD does not automatically mean moving into stronger currencies.

The risk to the diversification thesis is therefore continued US exceptionalism: stronger growth, higher yields and persistent US equity leadership. That is why this is a diversification argument, not a one-way bearish dollar call.