BETA
This is a BETA experience. You may opt-out by clicking here

More From Forbes

Edit Story

Currency-Hedged ETFs Better Be On Your Radar If Investing Globally

Following
This article is more than 8 years old.

When WisdomTree added a currency-hedging strategy to one of its Japanese equity ETFs several years ago, it wasn’t met with much fanfare.

“People weren’t interested in Japan at the time…it had been in deflation for 10 years,” Christopher Gannatti, associate director of research at WisdomTree said at a recent ETF.com Global Macro Conference.

A lot has changed since then.

Currency-hedged ETFs have become one of the most popular categories in the ETF universe. In the first half of 2015, they were one of the biggest asset gainers -- four out of 10 ETF with the largest inflows were currency-hedged products, according to ETF.com. In response to investor demand, ETF sponsors have also been increasing their currency-hedged product offerings by leaps and bounds.

This month, BlackRock added 11 new products to its currency-hedged iShares lineup bringing it’s total to 16; WisdomTree now offers 16 products as well and Deutsche Bank has 14. There have also been a bunch of newcomers to the space recently including State Street , PowerShares, ProShares and Direxion. More products are sure to come.

The growth in this category is partially due to the fact that ETFs make currency hedging easily accessible to investors for the first time.

“When we brought currency hedging to the ETF structure, that was the democratization of the strategy. It makes it easy for [everyone to use it] from the smallest retail investors to institutional investors,” Gannatti said.

In recent years this category has also benefited significantly from global developments, particularly in Japan and Europe, which have seen increases in their respective stock markets in tandem with steep declines of their currencies against the U.S. dollar.

http://www.flickr.com/photos/84987970@N00/3071916427">Volatile markets via photopin (license)

“Currency is most important issue that no one has had to worry about for 15 years,” said Richard Bernstein, chief executive and portfolio manager of Richard Bernstein Advisors who also spoke at the conference. Most global investors have had it easy over the past 15 years because the dollar was falling. Then the dollar was flat. But now it’s appreciated and, he said, “it has changed the whole tone of what global investing is about.”

“The dollar is going to be the secular winner,” he said which means, “If you’re going to invest globally, this is the most important issue.”  (For a comprehensive explanation about the impact that currency hedging can have on an investment, check out 2015: The Year Of Currency Hedging, by Matt Hougan, chief executive of ETF.com.)

Japan is a great example of the impact that currency hedging can have. After experiencing an extended period of deflation, the Japanese government began taking measures in 2013 to stimulate its economy (and continued to do so), which caused Japanese equities to rally while the yen plummeted.

“Japan equities have gone up and the currency depreciation has been significant,” Giannatti said adding, “It’s a natural impact of [quantitative easing (QE)]… hedging strategies become more interesting when you have QE.” The difference in returns between a hedged and unhedged portfolio of Japanese equities has been profound. Over the last three years, WisdomTree’s hedged Japanese equity ETF (DXJ) is up more than 66%, compared with a 33% rise in the unhedged iShares MSCI Japan ETF (EWJ).

European equities are experiencing a similar trajectory, though they are in the earlier stages of the process. After facing stagnant growth, the European Central Bank introduced a major quantitative easing plan earlier this year, which caused stocks there to rise while the euro tumbled to 12 year low against the dollar. As a result, year-to-date the WisdomTree Europe Hedged Equity ETF (HEDJ) has risen 13% compared with a rise of 6% for the iShares MSCI Eurozone ETF (EZU).

European currency-hedged ETFs were also the biggest asset gainers in the first half of 2015. HEDJ had the most inflows of any ETF -- nearly $14 billion.  The Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF) was second in line with flows of about $10.5 billion.

While currency-hedged ETFs cooled a bit in the second quarter compared with the first, experts believe there are still opportunities to be had, particularly in Europe.

According to Tom Lydon, president of Global Trends Investments and editor and proprietor of ETFtrends.com, European currency-hedged products will continue to be the big category winners going forward. “Greece unraveling will continue to hurt the Euro,” he said adding, “Don’t let the equity decline concern you. The ECB has probably had a Plan B to divest themselves of Greece and continue their path to recovery.”

“The ECB will continue to fuel the fire with their own form of QE which will further weaken the Euro….The Fed may delay the rate hike but we’ll see it prior to year-end. Rates go up, dollar goes up,” he said.

Gannatti added, “the dollar strengthening could continue...If the dollar continues to get stronger U.S. companies are running into the wind because their products are getting more expensive, while companies is Europe and Japan are on the other side. They’re selling products all over the world, which makes it easier for them.”