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Paul Baiocchi Analyst Blogs

Inside Europe’s Broken Hedge To Investors


Big chunks of money have been flowing into HEDJ in the hope that removing currency volatility from investing in debt-laden Europe will simplify the process.

The idea of currency-hedged investing isn’t new, and even in the relatively young tradition of the ETF industry, it has been discussed ad nauseam. The massive flows into the WisdomTree Japan Hedged Equity Fund (NYSEArca: DXJ) is perhaps the most glaring example of this.

Why then, has the WisdomTree Europe Hedged Equity Fund (NYSEArca: HEDJ) been raking in so much money, tripling its asset base in the process?

In the case of Japan, the reasoning was simple: Shinzo Abe was re-elected and immediately announced his intention to flood the market with yen via monetary and fiscal stimulus that could only be described as “shock and awe.”

The implications of such an audacious plan were telegraphed: Lower the value of the yen, increase competiveness of Japanese exports, and fuel a rip-your-face-off rally in the Japanese equity markets. If the proof is in the pudding, even Bill Cosby would approve: the iShares MSCI Japan Index Fund (NYSEArca: EWJ) is up 15-plus percent over the past year, while the db X-trackers MSCI Japan Hedged Equity ETF (NYSEArca: DBJP), its currency-hedged counterpart, is up 36 percent.

The simplicity of this trade—long Japanese equities and short the yen—perhaps fooled some into thinking that making a currency-hedged equities bet is a walk in the park.

The problem is that few, if any, central banks and elected officials are as transparent about their desire to subsequently debase their currency while overtly supporting asset prices. As such, it can be very challenging to accurately predict the direction of a move without the benefit of hindsight.

Perhaps this is part of the reason why so many of the currency-hedged products have yet to gain any meaningful traction. Before the big $120 million inflow into HEDJ, there was just $60 million invested in the fund.

The db X-trackers MSCI EAFE Hedged Equity ETF (NYSEArca: DBEF), which has 65 percent of the portfolio focused Europe, tracks the popular MSCI EAFE index (with a currency hedge) and currently has less than $30 million in assets.

The same goes for the db X-trackers MSCI Emerging Markets Hedged Equity ETF (NYSEArca: DBEM), the emerging markets fund tracking the currency-hedged version of MSCI’s Emerging Market Index. It has less than $10 million in assets.

It may be that most ETF users have little interest in parsing out their currency bet from their international equity bet.

Even that no-brainer, hedged Japan play has had its up and downs. Sure, the news from the end of last week that Japan was following through on its promise to buy everything from REITs to government bonds in addition to derivatives was met with a massive Sunday night sell-off in the yen and a rush into Japanese equities and bonds.

But the reality is that none of these things is black and white. In fact, most are more like manatee grey.

Which brings us back to HEDJ.




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