Strong Dollar Showcases Currency-Hedged ETFs

The stubbornly strong U.S. dollar might be creating headaches for anyone concerned by the country's debt and deficit levels or exporting goods outside the United States, but investors in the right foreign markets can find ETFs that are making the most of the dollar’s strength.

One of the best examples can be found in funds benefitting from currency disparity between the United States and Japan, where one dollar is worth 161 yen; up from 108 yen three years ago.

U.S. investors looking for exposure to the Japanese equity markets could buy the $15.6 billion iShares MSCI Japan ETF (EWJ), which has gained 7.2% this year. Or they could hedge out the currency disparity with the $374 million iShares Currency Hedged MSCI Japan ETF (HEWJ), which has gained 25% this year.

The stark difference in performance between the two ETFs offering exposure to the same underlying equity index boils down to the currency hedge that enables U.S. investors to earn the same performance as someone living in Japan.

“I think we’ll have a strong dollar for some time and the question for investors is how do you navigate that,” said Aniket Ullal, head of ETF Data and analytics at CFRA.

“Currency-hedged ETFs are products that investors haven’t fully adopted yet,” he added.

International Exposure?

Currency hedging is not something that can be applied globally because all currencies trade independently from one another. But if international exposure is the goal, investors can take advantage of the simple step of hedging out currency disparities where they exist.

In Europe, for example, where the dollar is currently worth 0.93 Euro, the strong dollar has resulted in a 5.6% gain this year for the $4.9 billion iShares Core MSCI Europe ETF (IEUR).

Meanwhile, the $1.7 billion WisdomTree Europe Hedge Equity Fund (HEDJ) has gained 8.1% this year.

Currency-hedged ETFs are still a relatively small category. Ullal counts 27 equity ETFs that combine for approximately $27 billion.

“This is for the U.S. investor who is fairly sophisticated,” he said, adding that performance of hedged-currency strategies would reverse if the U.S. Dollar were to weaken relative to other currencies.

“If the view you’ve taken is different from the direction of the currency market you could underperform,” he said. “It’s useful for investors who have a long-term view on the currency.”