Structure Matters: Schwartz On DXJ & Hedging

May 06, 2014

Weiskopf: How do you feel about the characterization that WisdomTree is a leader in the smart-beta category, and specifically, what does that label mean? Should we be looking at different labels, nonmarket weighting, or modern indexing?

Schwartz: We believe WisdomTree is a pioneer in the fundamentally weighted indexing —or “smart beta”—space. We think it’s beneficial for investors to start asking themselves, Should I be in just one investment strategy at the core of my portfolio?

When we launched WisdomTree, 95 percent or more of ETFs were market-cap weighted. While some market-cap-weighted strategies have served investors very well, they do have drawbacks, such as a lack of valuation discipline, and running into bubbles.

For example, Japan in 1989 was 60 percent of the MSCI EAFE index and dragged down the index return for 25 years as the country entered its bear market. We believe investors should look at a multidisciplined investment approach to their core equity allocations.

Weiskopf: Your firm is unusual in its ability to self-index. There have been multiple times where you’ve recalibrated some of your indexes—2011 and 2012. Would you speak a little bit about how decisions to recalibrate have been made?

Schwartz: Absolutely. We were the first ETF firm to “self-index” and had to get special exemptive relief to do so. These changes took time, diligence and required deep analysis. We are committed to our strategies, but we do monitor them and have the flexibility to make changes we believe to benefit the strategy and fund shareholders.

Mechanically, I should point out that there is a firewall between my indexing group and the portfolio management group. There’s a 60-day announcement time before any change we make to an index gets implemented. It has to get announced publicly (on our website) before the index change or before we can discuss with the fund operations group.

Weiskopf: Can you speak a little about the WisdomTree Japan Hedged Equity (DXJ | B-55), how that decision came about?

Schwartz: Back in 2008, the euro was around 1.60 [to the dollar], and thematically we had the idea that the euro may not go up forever versus the dollar, but that should not remove motivation to invest in European equities, which could do well if the U.S. economy is doing well.

Similarly, we felt the strength in the yen was self-destructive. There was a period of time between 2008- 2009 where every day the yen was rallying, and it was clear that this strength was creating competitive hurdles for key exporting companies like Toyota, Sony and Fujitsu, whose stock prices would move opposite the direction of the yen on a daily and long-term basis there.

We launched our first broad-based currency hedge ETF at the end of 2009, and then added a currency hedge to DXJ in early 2010 after many deliberations about how to make DXJ more unique. The idea was the yen could move 15-20 percent a year, and we could really differentiate the fund by adding the currency hedge element.

This made DXJ the first ETF of its kind to offer that type of exposure. DXJ started gaining traction over next few years, even though the yen kept strengthening longer term. We received feedback from a number of clients that if the yen were to eventually weaken, this could especially benefit export-tilted companies. We added an export tilt to DXJ in November 2012. (Note this was announced more than 60 days prior to that implementation given our disclosure requirement.)

After the new administration won the Japan election, our timing proved pristine, and we were able to share with investors research about how “Abenomics” might work to weaken the yen and support the equity markets.

We put a lot of work behind the various pieces of research, provided on our website, offering thought leadership for our investment themes and index strategies. Given the increasing investor interest in this area, Japan has been a particularly prominent research category on our site.


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