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Currency Hedging Working With EM ETFs, Too

When it comes to currency hedged exchange traded funds, Japan funds, such as the WisdomTree Japan Hedged Equity Fund (DXJ) and the Deutsche X-trackers MSCI Japan Hedged Equity ETF (DBJP) , have been joined in the limelight this year by a previously unheralded crop of ETFs that exploit dollar strength against developed market rivals.

The WisdomTree Europe Hedged Equity Fund (HEDJ) , Deutsche X-Trackers MSCI Europe Hedged Equity ETF (DBEU) and the Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF) have each not only proven to be prolific asset gatherers this year, but, more importantly, capable of generating superior returns relative to their unhedged counterparts. [Falling Currencies Buoy This ETF]

The currency hedged phenomenon can be applied to emerging markets ETFs as well and with emerging Asian currencies weakening, now could be the time for investors to consider the Deutsche X-trackers MSCI Emerging Markets Hedged Equity ETF (DBEM) .

Confirming that currency hedging is potent with emerging markets just as it is with Japan and Europe, DBEM is 2.3% over the past 90 days, which compares favorably with the average 6.1% loss for the iShares MSCI Emerging Markets ETF (EEM) and the Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO ) over the same period.

With emerging Asian currencies looking flimsy against the U.S. dollar, DBEM looks like a solid near-term emerging markets bet. [Currency Hedging Makes Sense With EM ETFs]

“A stronger US Dollar and weaker Asia FX is a clear talking point among investors as a ‘go with’ theme heading into 2015. The much weaker than expected inflation data in Singapore and Vietnam are just symptoms of a larger issue developing,” said Rareview Macro founder Neil Azous in a recent research note.

Since its September peak, the Bloomberg-JPMorgan Asia Currency Index (ADXY), a spot index of emerging Asia’s most actively traded currency pairs valued against the U.S. dollar, has lost over 2% and could be showing signs of rolling over.

As the currency hedged equivalent to EEM, DBEM features heavy short exposure to the currencies of China, South Korea, Taiwan and Malaysia, among others. Those countries combine for about half the ETF’s weight.

Predictably, China looms large in the equation. The yuan has been sturdy this year, making the short dollar/long yuan carry trade popular on currency desks. However, as Azous notes, “some paid forecasters are now arguing publicly that they dislike this short carry strategy,

some commentators are starting to argue that China has to enter the currency war by weakening the Yuan, and investors are becoming concerned that more policy easing in China will unleash a similar outcome this upcoming January to what happened last January, when many people got rinsed in this core carry position.”

China recently lowered interest rates and if that policy continues and/or the People’s Bank of China intervenes to weaken the yuan, DBEM stands to benefit.

Solidifying the thesis that weakening Asian currencies could serve as a catalyst for some upside for DBEM is the nearly 5% three-month loss for the WisdomTree Emerging Currency Strategy Fund (CEW) . That ETF allocates over 47% of its weight seven emerging Asia currencies. [Currency Concerns for EM ETFs]

Deutsche X-trackers MSCI Emerging Markets Hedged Equity ETF