Germany Euro Hedged ETFs Merit More Love

In the growing world of currency-hedged ETFs, Germany strategies are getting short shrift.

DennisHudachek_100x66.jpg
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Senior ETF Specialist
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Reviewed by: Dennis Hudachek
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Edited by: Dennis Hudachek

Currency-hedged ETFs are now all the rage. Sparked in 2013 by an Abenomics-induced plunging yen in Japan, the frenzy kicked into hyperdrive after the ECB’s stimulus announcement on Jan. 22.

Since the advent of Abenomics in late 2012, the WisdomTree Japan Hedged Equity ETF (DXJ | B-57) has ballooned into a $13.7 billion fund. On the European front, since Jan. 1, 2014, the WisdomTree Europe Hedged Equity ETF (HEDJ | B-51) has seen $9.9 billion in inflows and is now an $11 billion fund.

Yet it seems investors have forgotten to hedge out their currency risk in Germany, Europe’s largest economy and the brightest star within the eurozone.

Where’s The Love For Currency-Hedged Germany?

Currently, the unhedged iShares MSCI Germany ETF (EWG | A-96) is the undisputed leader in the space, with $5.8 billion in assets, accounting for 85 percent of the $6.9 billion in total assets in the segment.

In comparison, the three currency-hedged Germany ETFs have few assets. This is especially surprising being that Germany, like Japan, is an exporting powerhouse and largely benefits from a weaker euro.

Take a look at asset levels in hedged-Germany ETFs compared with EWG:

 

TickerFund Assets ($M)2015 YTD Flows ($M)
EWGiShares MSCI Germany*5,830*988
HEWGiShares Currency Hedged MSCI Germany845667
DBGRDeutsche X-trackers MSCI Germany Hedged Equity7530
DXGEWisdomTree Germany Hedged Equity6340

*HEWG's assets and flows get incorporated into EWG

 

Remember that EWG investors are fully exposed to movements in the euro, so the fund has taken a big hit compared with its currency-hedged peers over the past year due to the plunging euro. EWG is the black line in the chart below.

 

Chart courtesy of StockCharts.com

 

3 Different Flavors Of Germany, Ex-Euro

Ironically, the newest of three currency-hedged options, the iShares Germany Hedged ETF (HEWG | D-42), is now the leading fund. HEWG is quickly rising, with strong inflows in 2015, including $461 million in a single day.

 

Source: ETF.com

 

HEWG is a “fund of funds” structure, literally holding shares of the blockbuster ETF, EWG, with a forward-currency contract overlay to neutralize its euro exposure.

In terms of actual exposure, the Deutsche X-trackers MSCI Germany ETF (DBGR | B-70), which launched in June 2011, is virtually identical to HEWG. DBGR tracks a hedged version of the cap-weighted MSCI Germany Index, the same index on which EWG is based. (Also, remember that EWG is the underlying component of the hedged HEWG.)

The main difference between the two is that DBGR actually holds the underlying securities, instead of a single ETF position, as is the case with HEWG.

From a cost perspective, DBGR is the cheapest of the bunch, charging only 45 basis points. Better yet, the fund does a phenomenal job of tracking its index, trailing it by only a median 24 basis points.

While HEWG doesn’t have enough tracking data, since the fund holds EWG instead of a basket of stocks, it’s really about how well EWG tracks its index—which by the way, also happens to be phenomenal.

From a trading cost perspective, HEWG is clearly ahead here. The fund trades at 14 basis point spreads, compared with DBGR’s 23 basis point average spread.

The WisdomTree Germany Hedged Equity ETF (DXGE | B-66) offers something quite different. It not only selects and weights its securities by dividends, but also carries a small exporter tilt.

DXGE is basically the Germany version of DXJ. The two funds follow the same methodology, screening out companies that get more than 80 percent of their revenues domestically.

The Case For Euro Hedging

Even after the massive euro rout, some strategists are calling for parity with the dollar in the coming years. That may happen, but currencies are also extremely difficult to predict.

Some big questions surround the euro, which can change the path of the currency in the coming months and years.

What if the Federal Reserve holds off on raising rates? What if Greece leaves the eurozone, or stays in the eurozone, for that matter? Will the ECB be done with the current QE, or is there more to come?

What’s nice about currency-hedged ETFs like HEWG and DBGR is that they simply take the currency out of the equation, and don’t carry a net notional short position in the euro.

This means you don’t necessarily have to be bearish on the euro, but may simply want to protect yourself from FX volatility in case the unexpected happens. On the other hand, the exporter-tilted DXGE is designed to capitalize on a weakening euro environment.

Euro-Hedged Germany Lagging

Roughly 50 percent of the $30 billion in the Japan Total Market segment are held in yen-hedged ETFs. Within the $34 billion Europe Total Market segment, currency-hedged ETFs hold 37 percent of total assets, and they’re still climbing.

But in the $6.9 billion Germany Total Market segment, euro-hedged ETFs make up a measly 13.8 percent of total assets. It looks to me like hedged-Germany ETFs have been fairly passed over thus far.

As investors become aware of these products and the outsized returns they’re delivered over the past year, and faced with uncertainties about the euro, I only expect that percentage to rise in the coming year.


At the time this article was written, the author held a long position in HEDJ. Contact Dennis Hudachek at [email protected], or follow him on Twitter @Dennis_Hudachek.

 

 

Dennis Hudachek is a former senior ETF specialist at etf.com.