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DXJ: Currency-Hedged Power

March 13, 2012
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The yen is tumbling, and ETFs implementing a hedged-yen strategy are outperforming.

It’s not clear that the trend will continue, but the massive yen sell-off has been the biggest story in currency markets over the past month and, the way I see it, it’s a big ETF story too.

Before mid-February, the yen was on a multiyear tear, gaining over 35 percent against the greenback since 2007. It was easy to jump into ETFs like the iShares MSCI Japan Index Fund (NYSEArca: EWJ) which, unhedged, meant investors were also riding the yen’s appreciation.

But with the yen hitting record highs, I’ve thought for a while that the better way to play Japan was with a hedged-yen ETF. Last summer, for example, I blogged about the potential of the WisdomTree Japan Hedged Equity Fund (NYSEArca: DXJ) in a weakening yen scenario.

So when the Bank of Japan kicked things off in mid-February by saying it would increase its asset purchases by 10 trillion yen ($128 billion) to boost growth and set an inflation target of 1 percent, the wind was suddenly at my back.

And what a change. For years, the yen’s strength was attributed to several factors, including the heavy unwinding of the yen carry-trade following the financial crisis.

Adding to its rise were the repatriation of funds back to Japan following the March 2011 earthquake and the yen’s perceived status as a “safe haven” currency during the ongoing European debt crisis.

But over the past month, we’ve seen quite a shift.

The BOJ’s announcement, coupled with positive economic news about the U.S. economy; renewed hope for stability in Europe; as well as toned-down talk of another round of bond purchases (QE3) by the Fed, have caused the yen to fall more than 6 percent against the dollar since mid-February.

So, it’s time to dust off that old blog, and show with some real data why currency hedging makes so much sense for Japan.

The chart below shows the returns of DXJ and the db-X MSCI Japan Currency-Hedged Equity Fund (NYSEArca: DBJP) against the nonhedged EWJ, which has $5.3 billion in assets and is by far the most popular Japan ETF.

Also in the chart is the relatively new Maxis Nikkei 225 Index ETF (NYSEArca: NKY), which, like EWJ, isn’t currency hedged.

Bear in mind that during the past month, the Nikkei 225 Index has gained roughly 10 percent.

 

1-Month ETF Returns

Source: Bloomberg

 

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