Daily ETF Watch: 50% Hedged Funds Debut

July 22, 2015

Today, IndexIQ has rolled out its own contribution to the currency-hedged equity ETF space and put a unique twist on the concept. The three new funds are only 50 percent hedged, meaning that they only hedge away half of the foreign currency impact.

The new ETFs, their tickers and their expense ratios are as follows:

IndexIQ CEO Adam Patti notes that when IndexIQ spoke to ETF users, what the firm found was that investors were trying to time their hedging by switching between hedged and unhedged ETFs. And they weren’t doing a great job of getting their timing right.

“Market timing is a big question for anybody, particularly in the FX market, where it’s just extremely volatile and such a huge market and so liquid,” Patti said. “What we found was that they were mistiming the markets, and mistiming the markets is never a good thing.

There are a number of benefits to simply maintaining a steady 50 percent hedge rather than jumping back and forth between funds. For one, there’s significantly less volatility, according to Patti, but there’s also less hassle in terms of rebalancing.

If you hold hedged and unhedged versions of a fund, their performance will inevitably diverge, throwing off the allocations within the portfolio. That means you have to rebalance the portfolio on a regular basis – probably monthly or quarterly. Not only is it just one more item on your to-do list, but it also comes with added transaction costs.

Robert Whitelaw, IndexIQ’s chief investment strategist, further notes that because you would be selling off the outperforming fund to reset your allocations, the rebalancing would also have tax consequences in addition to trading costs.

“It’s a lot of work, and it’s costly,” Patti said. “We found that because some advisors were realizing they couldn’t time the markets, they were actually splitting their allocations anyway. They were going 50-50 in many cases.”

The Multi-Currency Issue

Another issue with hedged ETFs covering multiple currencies – such as an emerging markets fund – is that the fund applies a blanket hedge. So even though one currency might be weakening, another might be strengthening – hedging both would end up undoing some of the advantages of the concept. A consistent 50 percent hedge across all currencies can provide a sort of neutral starting point.

“We think that this is actually the optimal core holding for these exposures,” Patti said. It solves the problem of market timing for advisors, which you’re not going to get right unless you’re lucky – and no one’s lucky all the time. And it solves the cost of rebalancing and the tax issues.”

Investors with strong currency views could use the IndexIQ 50-percent-hedged products as their core holding and tilt their portfolios further by adding fully hedged or unhedged ETFs, depending on their views, Patti added.

“People talk about the unpredictability of currencies, but it’s also true across currencies. If the euro is weak, that doesn’t mean the pound is going to be weak,” Whitelaw said.

“If you were going to build an international portfolio and you were going to do tactical moves, you’d have to do it currency by currency, and that would be a really painful exercise,” he added. Instead, the IndexIQ fund HFXI could be used as a core holding, with an investor making tactical moves in addition to that position.

IndexIQ has two more of its halfway hedged ETFs in registration, the IQ 50 Percent Hedged FTSE Germany ETF (HFXG) and the IQ 50 Percent Hedged Emerging Markets ETF (HFXM). With the launch of those two products, the firm will have hit all of the “sweet spots” for currency hedging in the current market environment. All of the funds are listing on the NYSE Arca exchange.

iShares Japan Fund To Change Index

On or around Sept. 4, the $84 million iShares Japan Large-Cap ETF (ITF | B-97) will change both its name and its underlying index, becoming the iShares JPX-Nikkei 400 ETF. Currently, ITF tracks the S&P/TOPIX 150.

The new index, the JPX-Nikkei Index 400, covers small-, mid- and large-cap securities listed on the TSE First Section, TSE Second Section, Mothers or Jasdaq market.

But, in addition to the change, iShares has already filed for a currency-hedged version of the revamped fund. The iShares Currency Hedged JPX-Nikkei 400 ETF will invest primarily in ITF and apply a hedge via one-month foreign currency forward contracts. Investors will be able to toggle back and forth between the two as needed.

Although the currency-hedged ETF space is largely dominated by WisdomTree these days—the WisdomTree Europe Hedged Equity ETF (HEDJ | B-47) alone has nearly $22 billion in assets—iShares has been making inroads in offering investors a choice. HEDJ has no unhedged counterpart, but most if not all of the iShares currency-hedged ETFs have unhedged counterparts that represent the bulk of their portfolios.

The filing for the hedged version of ITF does not include a ticker or expense ratio.

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