Currency Hedge Stars of 2015 Will Repeat
Soon after the arrival of Abenomics and Japan’s aggressive moves to weaken the yen, the ETF industry’s move into currency-hedged products really took off in 2013 with the WisdomTree Japan Hedged Equity (DXJ | B-70). That year saw nearly $10 billion flow into the fund, as well as being one of the best-performing ETFs of the year.
Weakening its currency to help make exports cheaper clearly worked, sending Japan’s stock market surging. But the next year, as the yen stabilized against the dollar, the trade lost its sheen, and investors retreated, taking more than $400 million out of the fund. But instead of the currency-hedged phenomena fading, the second leg of the trend was just warming up in Europe and other parts of the world.
With the eurozone still mired in a recession, the European Central Bank began signaling it would be launching its own quantitative easing program if needed, which it did in January 2015. That ushered in the second act of the currency-hedged trend and put the spotlight on two ETFs in particular.
Realizing the eurozone was headed for the same monetary fate as Japan, investors began piling into two ETFs toward the end of 2014 that would produce similar results as DXJ: the Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF | B-71) and the WisdomTree Europe Hedged Equity (HEDJ | B-49).
While more than $6 billion flowed into those funds then, it was 2015 when DBEF and HEDJ became the new stars of the ETF world as the ECB unleashed its own QE program. Not only did the funds live up to the outperformance promise, DBEF and HEDJ saw $12.7 billion and $15.6 billion in inflows, respectively, through November 2015.
Heading into 2016, the fundamentals for these funds—stronger dollar and weakening euro—have actually improved, which is why we feel these two ETFs are set up for a repeated performance, and will again be the top asset gathers and continue to outperform U.S. stocks.
“We’re on a precipice poised to actually have the Fed zig while the European Central Bank is zagging, and it’s looking very, very imminent,” said Shehriyar Antia, former official at the New York Federal Reserve, and founder and lead strategist of Macro Insight Group, an investment strategy firm based in New York. “We’ve never had stronger signs of divergence in the immediate future than we have now.”
However, he cautions that investors looking for short-term gains could be disappointed.
“If you want to get into that trade, you have to look further out than the next two or three months,” he said. “You have to look forward to 2016. There’s room for the dollar to grow even stronger because of the market being complacent about inflation.”