As overseas governments implement loose monetary policies and the U.S. dollar strengthens, currency-hedged exchange traded funds are becoming a popular, targeted play on international equities.
“You’re definitely seeing investment advisers become much more aware of the currency risk that they’re running,” Deutsche Bank’s Martin Kremenstein said in a MarketWatch article. “For the last 10 years, up until about a year ago, it was basically a free ride. The dollar was declining. You essentially always came out ahead out by not hedging. That paradigm has now ended.”
Most country-specific and international equity ETFs hold stocks denominated in their respective domestic currencies. If the U.S. dollar strengthens and the foreign currencies depreciate, the foreign equity ETF would take a hit when converting the weaker currency to the U.S. dollar.
“If investors are currently investing internationally, they are making a short bet on the U.S. dollar through that investment,” Kremenstein added. “If that isn’t exactly what they want to do, then they should consider using a currency-hedged product, either on its own or in conjunction with an unhedged product.”
The shifting investment environment is also stirring competition in the currency-hedged space. BlackRock’s iShares recently filed for its own line of ETFs that mitigate currency risk. [iShares Heats Up Competition in Currency-Hedged ETF Space]
The WisdomTree Japan Hedged Equity Fund (DXJ) has been the most popular ETF this year as investors capitalized on the aggressive Bank of Japan monetary policies and a quickly depreciating yen. Deutsche Bank also offers its own Japan yen-hedged equity fund, the db X-trackers MSCI Japan Hedged Equity Fund (DBJP) . [Breaking Down the Two Largest Japan ETFs]
Looking ahead, the eventual Fed tapering and rise in interest rates would help support the U.S. dollar. The ICE dollar index, which tracks the greenback against a basket of six rival currencies, has gained 1.3% over the past year.
For more information on country-specific funds, visit our global ETFs category.
Max Chen contributed to this article.
Full disclosure: Tom Lydon’s clients own DXJ.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.