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Is 50% Hedged ETF is a Good Idea? - ETF News And Commentary

Zacks Equity Research

U.S. dollar strength is on a roller-coaster ride this year with the currency strengthening massively in the early part of the year on rising rate speculations in the U.S. but falling against a basket of key global currencies since April 2015.

Market participants were earlier strongly wagering on the faster-than-expected rise in Fed rates  that fuelled the strength in the greenback, but the bet was quelled soon after the Fed showed incredible patience in the hiking the key rate in the U.S. The Fed has cited ‘moderation’ in the U.S. growth rate in Q1 as a reason for the delayed rate hike.

If this was not enough, the Fed recently indicated that U.S. stocks are moderately overvalued. All these led the greenback to step down from the lofty level it was at to start the year. Investors should note that while the rising rate prospect is the most discussed topic this year in the U.S., most developed nations across the globe are mulling over policy easing.

Japan has extended its already gigantic stimulus measure in October 2014; the ECB rolled out the QE measure in the Euro zone, and a host of nations slashed their benchmark rates with some of them being the emerging markets. This policy differential made the greenback a king to start 2015. But since Fed rate hiking move appears a rather distant prospect, the concept of currency hedging pertaining to international investing is falling out of investors’ favor.

Notably, currency hedging is a beneficial technique when the USD is strengthening relative to the concerned foreign currency. But investors would incur losses on repatriating their foreign income while the USD is falling (read: Top Ranked Currency Hedged ETFs in Focus on Dollar Surge).

Inside USD Move

The U.S. dollar lost about 5.3% in the last one month (as of May 13, 2015) against the euro, 0.07% against the yen, 5.3% against the German mark and 6.4% against the British pound. WisdomTree Emerging Currency Strategy ETF (CEW), which measures changes in the value of emerging market currencies relative to the U.S. dollar, also added about 0.7% over the last one month.

What Should be Your Hedging Strategy?

Currency hedging as a concept flopped in the last one month as most hedged ETFs retreated during the timeframe. The biggest loser (down 6.9%) was Currency Hedged MSCI Germany ETF (HEWG). Yet the idea will once again take center stage latter this year (read: 3 Best Performing ETF Sectors of Q1 2015).

After all, the rate hike is long due in the U.S. Moreover, the April jobs data points toward a healing labor market. The report matched estimates having created 223K jobs in the month versus the prior month’s count of 85K. This once again brought rate rising talks on the table.

On the other hand, given a flurry of cheap money, all struggling developed nations will start showing signs of improvement which in turn will boost their respective currencies. The Euro is a clear example of this trend as the currency lately strengthened on the pickup in the Euro zone economy (read: Is The Worst Over For Euro ETFs?).

In such a backdrop, a 50% hedged ETF can be an intriguing option to minimize risks and sail through all types of market dynamics. This is more applicable  for emerging market ETFs as this slice of the globe still follow relatively tighter policies (read: Emerging Market ETFs in Trouble on Stronger Dollar?).

Is Any Product Available with 50% Hedging Strategy?

Probably having the same idea, Index IQ recently filed five passively managed 50% hedged ETFs. These are IQ 50 Percent Hedged FTSE International ETF, IQ 50 Percent Hedged FTSE Europe ETF, IQ 50 Percent Hedged FTSE Germany ETF, IQ 50 Percent Hedged FTSE Japan ETF and IQ 50 Percent Hedged FTSE Emerging Markets ETF. Ticker codes and expense ratios for the ETFs are yet to be disclosed.

These ETFs follow benchmarks including the FTSE Developed ex North America 50% Hedged to USD Index, the FTSE Developed Europe 50% Hedged to USD Index, the FTSE Germany 50% Hedged to USD Index, the FTSE Japan 50% Hedged to USD Index and the FTSE Emerging 50% Hedged to USD Index.

The indices are the equity gauge of related region stocks and consider about half of the currency exposure as being hedged against the greenback on a monthly basis, as per the prospectus.

Bottom Line

50% currency hedging is undoubtedly an innovative idea. So, if investors like the theme, the proposed funds by Index IQ would not face much peer pressure, if these get approval.
In the current macro economy, we assume that emerging market ETFs should be the most popular (as hedged ETF is not that a lucrative proposition in that field) and Japan ETF might not see enough success. Given Japan’s huge asset buying program, a hedged approach still appears safer to play the country.

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