New Wrinkles For Currency Hedging ETFs

October 23, 2015

At the beginning of the year, ETF.com’s Matt Hougan called it: 2015 would be the year of currency hedging.

Now, as we approach the end of the year, it should be noted that currency hedging in ETFs has been a hot trend, as inflows reflect. Just as important, though, performance has stalled in many of these funds, even as the segment continues to welcome new and interesting takes on the theme.

After the huge success last year of the WisdomTree Japan Hedged Equity ETF (DXJ | B-68), which went on to become a $10 billion ETF in a matter of months in 2014, and perhaps the poster child for the currency-hedging ETF phenomenon, 45 out of 234 new ETF launches this year have been currency-hedged strategies.

The biggest ETFs in the segment, the WisdomTree Europe Hedged Equity ETF (HEDJ | B-50) and DXJ have $19 billion and $15 billion in assets, respectively—$34 billion in two ETFs alone. Impressive when considering those inflows came in approximately the last 18 months.

Clearly, investors are starting to understand that when you invest in international stocks, currency moves matter.

Yen Devaluation The Trigger

If we were to pinpoint the event that put currency hedging on investors’ radars for good, it would be the election of Japan’s Prime Minister Shinzo Abe in 2012. After he took office, he began pursuing policies that would weaken the yen.

Soon afterward, investors began to see what a currency’s devaluation can do to a country’s stock market.

Abe, and the weakening yen, unleashed a wave of currency-hedged ETF launches that’s showing no signs of slowing down. In fact, this week, the latest ETFs to join the segment also happen to be first-of-a-kind funds. They are currency-hedged China ETFs.

There are several reasons hedging currency exposure in a portfolio of Chinese stocks suddenly seem like an appealing idea. For years, China supported an implicit peg between the yuan and the dollar, which made the need for currency hedging practically nonexistent for U.S. stock investors with exposure to Chinese equities. But back in August, China took steps to devalue the yuan in a move that surprised the market.

Currency-Hedged China Funds Arrived

There’s also the issue of increased access to Chinese stocks. China’s mainland stock market—securities known here as “A-Shares”—are increasingly accessible to U.S. investors. There are already at least eight ETFs in the market today offering exposure to Shanghai-and Shenzhen-listed securities.

Thus, it only makes sense that with that backdrop, currency-hedged China ETFs would eventually make it to market. This week, Deutsche Bank rolled out the Deutsche X-trackers CSI 300 China A-Shares Hedged Equity ETF (ASHX), which is a currency-hedged version of the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR | D-53), a $573 million fund.

The prospectus indicates that ASHR will be ASHX’s primary investment. ASHX comes with an expense ratio of 0.85 percent, five basis points more than that charged by ASHR.

Hong Kong-based CSOP Asset Management also launched a pair of China-focused ETFs this week, one of them the CSOP MSCI China A International Hedged ETF (CNHX). And there’s at least one other currency-hedged China ETF already in registration.

Popularity Doesn’t Equate To Performance

If investors are tuned in to the fact that currency exposure impacts stock returns, and they are buying into the currency-hedged ETF craze, they are also faced with the reality that hedging may be cool, but it doesn’t always means outperformance.

Consider the performance of DXJ—2014’s market darling—and its unhedged counterpart, the iShares MSCI Japan ETF (EWJ | B-98) over the past one year:

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