The newest iShares ETF, the Currency Hedged Global ex USD High Yield Bond ETF (HHYX), launched this week, is noteworthy for two reasons. First, it’s iShares’ first currency-hedged bond ETF, and one of a still-very-small group of strategies that attempt to mitigate currency risk on international bond portfolios. Secondly, it should fill an important void if the performance of its nonhedged counterpart is any indication.
Here’s why HHYX matters:
- HHYX is a first for the largest ETF issuer in the world, and some say the international bond space is where currency hedging is most useful.
Currency hedging in an environment marked by a strong—and strengthening—U.S. dollar has proven popular and effective in the equities space. Some of the biggest asset-gathering ETFs in recent months have all shared a currency-hedging feature that aims to protect U.S. investors from currency risk—a risk that seldom pays off in the form of additional returns.
“Exposure to currency risk is an uncompensated risk,” Betterment’s Ellie Lan said in a recent blog noting that investors need exposure to international bonds, but not to currency risk.
“Changes in exchange rates create return volatility without introducing additional expected returns. While rate changes may randomly add returns in your favor in the short term, the expectation should always be of zero return over the long term,” she said.
Hedging Works Better With Bonds
In the fixed-income space, HHYX is one of a select few ETFs to offer access to a global bond portfolio that mitigates that risk through a currency hedge. The ETF invests primarily in its nonhedged counterpart, the iShares Global ex USD High Yield Corporate Bond ETF (HYXU | C), owning high-yield bonds denominated in euros, British pounds sterling and Canadian dollars, and using foreign currency forwards to hedge exposure to these currencies.
“Whether it's stocks or bonds, currency does not contribute substantial returns; however, it has a substantial risk in terms of volatility, and all the more so when it comes to bonds,” Lan said. “The increase in risk of not hedging bonds is significant and cannot be overlooked.”
Citing Vanguard data, Lan noted that currency hedging is beneficial for bonds but not for stocks.
“This is because of the different volatility characteristics of stocks and bonds, and their correlations with currency moves,” she said. “Bonds, as an asset class, are typically less volatile than both stocks and currencies.”