How Dynamic Currency Hedged ETFs Work

February 03, 2017

The goal is not to get every currency bet right 100% of the time. When you have these four- to eight-year moves in the dollar, the goal is to capture the lion's share of the movement in the sense that if you're predominantly hedged, you don't get that 4-5% a year head wind on the struggling dollar, which is one of the things that impacted international equity returns these last five years.

It's no coincidence that emerging markets is basically flat over five years, and EAFE, I think, returned more than a percent for 10 years. A good portion of it is the head wind caused by that rising dollar.

The goal is to get hedged when the dollar is strengthening, and then to remove the predominance of the hedges as the dollar's declining in value. Those movements tend to last six, seven years and they tend to net out over time. But if you can capture the lion's share each way, we think there's a way to add value. And there’s a small-cap version, too?

Siracusano: There's the WisdomTree Dynamic Currency Hedged International SmallCap Equity Fund (DDLS), where we hedge out the currency dynamically in the international small-caps. We're also doing it now in Japan [the WisdomTree Dynamic Currency Hedged Japan Equity Fund (DDJP)] and in Europe [the WisdomTree Dynamic Currency Hedged Europe Equity Fund (DDEZ)]. Is there the potential those would cannibalize your straight-hedged products?

Siracusano: I don't think so; it's just completing the product suite and it's giving people three ways to get the exposure. We're giving a way to own that exposure hedged, or dynamically hedged or unhedged.

Historically, investors would outsource it to an active manager, but the problem is that most active managers really don't manage currency risk very well. If you look at EAFE hedged over the last five years, it beats about 99% of the active managers in the international space. What that means is that the active managers have not been managing currency risk.

If you want to outsource that decision, we’ve created a dynamic hedged strategy that does that. It makes the decision for you at the end of every month about what currencies you should be hedging. And it's not as if we're hedging them 100%; there are gradations. Some are hedged 33%, some are hedged 50%, some are hedged 83%. Let’s talk about Japan. The economy there seems to be in a quagmire.

Siracusano: It takes a long time to change direction of that aircraft carrier, if you will. We have a team in Japan on the ground, and they say there’s been a pickup in sentiment the last quarter. We're starting to see a bottoming to the disinflationary trend, which is really the big thing. If they can get inflation to start picking up, that's very productive.


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