This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Deborah Frame, vice president of investments at Toronto-based Cougar Global Investments.
Amid forecasts for the dollar’s rally extending through 2015, U.S. investors are focusing on exchange-traded funds that protect them against foreign-exchange losses.
Assets invested in U.S. exchange-traded funds that hedge currency risk grew 18 percent between Sept. 30 and Nov. 20 to $21.2 billion, according to data compiled by Bloomberg. That’s the largest quarterly increase since mid-2013.
Currency-hedged ETFs are proving to add value. Consider the following two comparisons:
- While the $4 billion WisdomTree Europe Hedged Equity Fund (HEDJ | B-54) returned 3.1 percent this year, the unhedged $7.4 billion iShares MSCI EMU ETF (EZU | A-63) that also invests in European stocks lost 7.7 percent.
- In Japan, where the benchmark Nikkei 225 stock average has risen to a seven-year high even as the yen has tumbled to a seven-year low, the WisdomTree Japan Hedged Equity Fund (DXJ | B-64)—the largest currency-hedged fund at $12.6 billion—has returned 8.6 percent in 2014. That compares with a loss of 4.2 percent for the iShares MSCI Japan ETF (EWJ | B-98), a $15.6 billion ETF that’s not hedged.
While currency hedging has been widely embraced in the past few years, the extent to which currency hedging is warranted and why is primarily separated into two types of expected foreign currency behavior.
Specifically, investors need to be mindful of the differences between reserve currencies and commodity currencies.
What The Research Says
While the nuances that distinguish the two types of currencies may not appear as relevant in the post-2008, and post-global quantitative easing (QE) world, the future will bring us back to normalization of foreign exchange risk.
Hedging, or, more generally, currency exposure, affects both the return and the risk of foreign investments. From a risk perspective, we find that, for bond portfolios, full hedging is the optimal strategy in almost all cases.