The dollar is trading at historic highs against the euro, nearing parity in a global economy that’s largely fueled by unprecedented levels of quantitative easing. The developing trend in the euro offers opportunities for ETF investors, Eric Mustin, vice president of ETF Trading Solutions at WallachBeth Capital, says.
He shared with us some of his views on how investors should look at these currency crosses, and what strategies are working in the current environment.
ETF.com: The euro has dropped by 20 percent against the dollar since last summer, and many say the decline is going to continue. What’s your view on this currency trend? Do you think the dollar rally is overdone?
Eric Mustin: I think over the long term, the euro is going to slide closer to parity, but in the short term, given the upcoming Fed statement, there could be some chop, and a slightly more dovish Fed statement than expected could lead to a reversal of the trend we are seeing.
In the short term, it’s difficult to say which way we are going to go. But over the long term, we are going to see the euro continue to weaken, and on the flip side, the dollar continue to strengthen as the Fed moves towards higher rates.
ETF.com: So the first decision an ETF investor has to make when looking for opportunities in this trend is whether they are going to focus on the short term or the long term?
Mustin: ETF investors should not be using ETFs for short-term tactical exposure. It’s a zero-sum game. If you are going to take a view, I think it needs to be a fundamental long-term view. It needs to part of your overall allocation.
You are not taking a certain percentage of your capital and buying currency futures, but you are allocating among a number of different sectors, and then trying to diversify those allocations so that they are not all dollar-denominated.
ETF.com: There’s been a clear demand for currency- hedged strategies like the WisdomTree Europe Hedged Equity ETF (HEDJ | B-51). Is that where you see most opportunity—in that type of strategy?
Mustin: There have been considerable flows into HEDJ—about $7.7 billion year-to-date. But we’ve also seen flows into other areas that are indicative of good opportunities—developed-markets hedged equity products such as the Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF | B-71) as well as the iShares Currency Hedged MSCI EAFE ETF (HEFA | D-41).
These have taken in about $3.6 billion and $1.5 billion inflows, respectively. It’s not only a play on euro weakness, but general competitive devaluations from central banks in developed-market countries. DBEF and HEFA allow you exposure to central bank policies in Sweden, Japan, etc. All of these countries are trying to lower interest rates.
Across the board, you are seeing not just the ECB, but a number of countries looking to devalue. These ETFs allows you a little more diversified exposure to those trends.
ETF.com: Do you anticipate these asset flows to slow down, or are you hiring more people to manage the phones? This is all pretty unprecedented territory with all of this QE globally.
Mustin: Frankly, I think it’s a little bit overdone in the short term. It seems like everyone and their mother is trying to use currency-hedged ETFs. Just as likely as there’s an environment with a strong dollar and a weak euro, eventually, there’ll be an environment with stronger developed-market currencies and a weaker dollar.
The key is understanding how these currency-hedged ETFs fit in a wider portfolio. It’s not an all-or-nothing bet, and some investors are starting to understand that you just want to have currency diversification in general.
It’s about diversifying risk so that not too much of your alpha is ruined by any significant move in the currency. I think that’s going to be the trend going forward—where investors learn to use this as a piece of their portfolio, and not as an all-or-nothing shot.