China, in a surprising move today, devalued the yuan relative to the U.S. dollar, raising the question as to whether ETF investors exposed to Chinese markets now have to worry about the need to currency-hedge that exposure.
Currency-hedging has been the hottest theme in international equity investing in the ETF space all year as central banks across the globe take action and intervene in currency markets.
Investors today who own exposure to international stocks have a two-pronged concern: whether they want exposure to that country, and whether they want exposure to the currency of that country.
Thanks to a vast number of currency-hedged ETFs in the market today, investors are now more aware than ever before of the impact currency fluctuation can have on total returns. As such, currency-hedged ETFs have been some of the most popular funds in a year when investor demand for non-U.S. exposure has grown.
No Currency-Hedged China ETFs Yet
But as of today, there are no currency-hedged China ETFs. There are two funds in registration from KraneShares and CSOP, but with an implicit peg between the yuan and the dollar for years, there’s never really been a need to worry about currency fluctuations and its impact on total returns. That could be about to change.
Hong Kong-based CSOP filed for the CSOP MSCI China A International Hedged ETF, which would combine A-shares exposure with currency hedging. The fund would be the first China equities ETF to come to market with a built-in hedging mechanism. KraneShares has also recently updated its regulatory filing for a hedged version of its latest fund, called the KraneShares E Fund China Commercial Paper Hedged ETF (KEEP), but that’s a fixed income fund.
What happens next is obviously crucial to whether currency-hedging China exposure becomes a theme. If the Chinese government’s messaging is any indication, it might not be that important because they are saying they have no intention of intervene further. But that remains to be seen.
“The government said this was a one-time adjustment and the currency will be stable going forward,” Brendan Ahern of KraneShares told ETF.com. "The yuan has been exceedingly strong versus the dollar, having appreciated 7 percent over the last five years. Relative to other emerging market currencies, it is a standout.”
But China is on a mission to have the yuan declared a reserve currency by the International Monetary Fund, and today’s depreciation will bring the yuan in sync with other currencies relative to the dollar, Ahern says. It will also help exporters to a certain extent.
“The peg has made hedging unnecessary, historically,” Ahern said, noting that a long period of high interest rates in China has also made the idea of hedging cost-prohibitive.
“China’s interest rates have come down over the last several months, though historic high interest rates made hedging very expensive,” he said. “Hedging is giving someone the interest rate that would have been earned, and for many emerging market countries with high interest rates, this makes hedging very expensive.”
If devaluation goes on beyond today’s move, hedging—however expensive—might become a good idea for ETF investors.
Contact Cinthia Murphy at [email protected].