Martin Kremenstein, the head of Deutsche Bank’s U.S. ETF business, looks at the investment landscape, and senses a distinct possibility that the dollar may well be on the verge of starting a strengthening trend. That, of course, will constitute a radical reversal of the dollar weakness since the tech bubble burst in 2000.
The problem is that most U.S. investors have grown so used to having international investments that have received a significant boost from a weak dollar that they really have very little idea of how to deal with a Brave New World of renewed dollar strength. Luckily they have exchange-traded funds at their disposal, such as the db-X MSCI Japan Currency-Hedged Equity ETF (NYSEArca:DBJP, to pull the currency-cross variable right off the table.
But will they realize the existence of such useful tools in time to prevent a train wreck, and will they realize it in time for Deutsche Bank’s currency-hedged ETFs to get the love from investors they so plainly need and deserve?
IU:I wanted to get your take on what ETF investors should be looking out for in 2013, but let’s start with Japan since Japan is in a way the news of the day. Given the new leadership there, and the expected impact it will have on the yen, is this the time for DBJP to shine?
Kremenstein: If you are long Japanese equities and you haven’t hedged out that currency exposure, it’s going to be quite hard for you to take advantage of this improved environment for Japanese companies. Definitely the way to get your exposure to Japan is to hedge out your currency exposure.
IU:In a broader sense, do you see Japan as a place where U.S. investors should be invested, or is this just an opportunity given the change in leadership?
Kremenstein :Japan is a very important economy and an investor should have exposure to it. It has performed poorly because of the extreme strength of the yen, but if the yen weakens, it’s a very good investment. Japan is very well positioned to tap into any uptick in activity in China as well as from any recovery in U.S. and Europe.
IU:What are the biggest challenges facing investors next year?
Kremenstein :I think where there’s going to be a challenge for investors is where they have foreign-currency denominated assets. Because those get revalued into dollars, if we have dollar strength, investors are going to take a hit on those assets. It goes back to the idea that you need to start managing your currency exposure in your international equity and bond allocations.
IU:Let me go on a tangent here and talk for a second about energy. The S'P GSCI increased its weighting to Brent at the expense of WTI. What do you make of that change? Does it affect at all how you perceive energy investments going forward?
Kremenstein :The GSCI works on dollar production and Brent is becoming a more important part of the energy landscape for two reasons. First, it’s closer to a lot of emerging markets, and secondly, because it’s lower quality than WTI, it’s easier to turn into diesel, which is the predominant fuel in emerging markets. That’s just reflecting Brent’s continue importance—we’ve always had Brent as equal weighted to WTI because we see them as equally important. What that means for investors, is that we should see money flowing from one to the other and should be net neutral for investors.
The other thing is that Brent is in backwardation at the moment, so it’s a good time to invest in it, where it’s a little bit tougher to be in WTI because it’s in contango. However, by the time you get into something that’s in backwardation, you might have already missed out a lot on the price move, so there’s a chance that the GSCI is moving into Brent as it’s approaching some kind of near-term top.
IU:Going back to currency and the db-X lineup of currency-hedged ETFs:They are such interesting products and yet they seem to be struggling to get traction. What do you make of this apparent lack of investor interest, if you will?
Kremenstein :For a lot of investors, if they are worried about dollar strength, they tend to just pull back from international markets rather than just hedge out that exposure. So we need to educate investors on the effect the currency has on their returns.
The dollar has been so massively in their favor for so long that they haven’t concentrated on that. It reminds me of back in 2006-07, when we were talking about roll yield on commodity funds and people weren’t really listening until we hit 2008 and the markets were so persistently contangoed that they started listening.
It’s going to take a period of pronounced dollar strength to really show investors how much they can benefit from hedging. But I’m confident that the increased distribution we are going to have and where we see the dollar going next year that we are going to start to see traction in these products.
IU:I gather that the takeaway themes for investors in 2013 are Japan, the dollar, and increased commodity exposure. Anything else, particularly as it relates to the fiscal cliff?
Kremenstein :I think one of the key things next year is where the euro goes. They’ve been trying to figure out how to shore things up over there for 18 months now, and it’s a question of whether they are able to put that issue to bed finally.
The issue here is that there is a lot of investor fear and that can hurt sentiment, and that makes investors less likely to invest. Once we get a clearer investment landscape you start to see more money coming in from the sidelines and that’s good for everybody.
IU:Final question:What’s your view on what 2012 has meant for the ETF industry? We saw launches decelerate, closures accelerate to unprecedented levels, and yet assets are at record highs.
Kremenstein :I think the market is evolving, and there are several phases. You have the start-up phase, or the original creation phase with things like SPY and QQQ, and then you have iShares kind of dominating the space for much of the early 2000s, and then smaller firms started to show up, turning the ETF market into a more competitive space, and what you are seeing now is a bit of a shake-out of the smaller players in the space.
On the other hand, there’s been a host of active managers who are filing, so that may well be the next big wave of growth for ETFs:active management. We saw BOND just absolutely shoot the lights out with their debut, and that will probably encourage more active management in the space.
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