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As Dollar Continues to Strengthen, Time for Hedged Currency ETFs?

Zacks Equity Research

As the QE wrap-up started to wreak havoc on international markets, investors in the ETF world felt the brunt of negative currency translation on foreign holdings. Many currencies are slumping against the U.S. dollar, which is having an adverse impact on stock prices when U.S. investors repatriate returns earned from foreign shores.

This is especially true given Bank of Japan’s (:BOJ) latest decision to step up its already massive stimulus program.  BOJ will now buy about ¥80 trillion in bonds every year, up from the previous ¥60– ¥70 trillion range.

Notably, in April 2013, the BOJ launched a major quantitative easing program in an effort to curb the country’s deflation levels and weaken the yen even further. The BOJ then planned to double its money supply and achieve a 2% inflation target within two years. 

Crumbling Yen 

A sliding currency is always boon to the export-oriented nation like Japan. A weaker yen makes Japanese products more competitive on the global market, boosting the profit margins for their key businesses (read: Japanese Yen ETF Investing 101).

As a result, the Japanese policy makers were successful in pushing the yen lower by as much as 15% in 2013. While the currency started 2014 on strong footing thanks to a slump in the greenback (in wake of a slew of downbeat U.S. economic data), it eventually lost about 4.2% of its value in the first three quarters in the year on rising rate and taper concerns in the U.S.

Finally, following the latest announcement of liquidity injection in late October, the yen has depreciated more than 6.5%. Though the yen gained some strength on November 17 following the announcement of Japan slipping into recession in Q3 like in Q2, we expect the rebound in the yen not to last long.

Slump in Euro

Though the Euro zone emerged out of a two-year long debt crisis in the second quarter of last year, it failed to sustain the wining momentum in 2014. Most of the foremost nations of the continent are presently dragging their feet in terms of economic growth, with some slipping into another recession (read: Short the Euro with These Inverse ETFs).

Deflationary worries returned to the picture again letting down the European Central Bank’s (:ECB) directive to maintain inflation rates close to 2% per year. As a result, the ECB announced a cut in its benchmark rate to 0.15% from 0.25% in June and introduced a negative deposit rate (-0.1%) as a first for a major central bank.

If this wasn’t enough, the ECB will soon launch an asset buy-back program as an added measure to close out the year. Notably, the bank has already started buying covered bonds. As a result, a likely flush of liquidity depressed the common currency, the Euro. Since July, the currency lost about 8.3% (as of November 13, 2014) against the greenback.
 
Thanks to this currency issue, investors need to be vigilant while picking up foreign assets and consider the dollar’s possibility of gaining more strength following the hike in interest rates next year. There isn’t anything more unfortunate than seeing one’s substantial portfolio additions fail because of soft foreign currency.

Slide in South Korean Won

Meanwhile, the Korean government unveiled an $11 billion stimulus package this year to bolster its weakening economy over and above the two rate cuts. As a result, the greenback has strengthened about 8.7% relative to the won since the start of September.

Investors should note that South Korea, with its massive current account surplus, huge foreign exchange reserves and brilliant institutional framework, should emerge as a solid long-term pick (read: Emerging Market ETFs: Any Bright Spots?).

Currency Hedged ETFs to Rule

The above discussion has made the importance of hedging clear to many investors who may not have realized that a bet on a foreign market is not only a purchase of stocks or bonds in the country but a lot to do with currency translation as well.

This is because the ongoing and potential dollar strength may eat up the returns earned from the countries marked with immense potential but weak currencies.  Hence, to ride out this currency concerns, it is better to opt for currency hedged ETFs in the days to come.

For investors intrigued by this strategy, there are a few options currently on the market. Below, we briefly highlight some of these choices for investors who believe that the dollar has a lot of room to run next year but are looking to maintain some level of exposure to foreign markets nonetheless:

WisdomTree Japan Hedged Equity Fund (DXJ) and Deutsche X-trackers MSCI Japan Hedged Equity ETF (DBJP) each has a Zacks ETF Rank #2 (Buy). Within the last one month, both ETFs have returned more than 15% each while the unhedged version iShares MSCI Japan ETF (EWJ) has added about 7.5%.

WisdomTree Korea Hedged Equity ETF (DXKW) and db X-trackers MSCI South Korea Hedged Equity Fund (DBKO) – each a Zacks ETF Rank #1 (Strong Buy) hedged South Korean ETF – returned more than (1.6% and 3.1% respectively) unlike the unhedged ETF iShares MSCI South Korea Capped ETF (EWY) in the last 4-week period. Notably, EWY lost about 0.4% during this time frame.

Coming to Europe, Europe Hedged Equity Fund (HEDJ) has added about 5.3% over the last one month while SPDR Euro STOXX 50 ETF (FEZ) was up about 2% (read: Hedged European ETFs in Focus: Best Choice for Europe Now?).
 
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Read the analyst report on DXJ

Read the analyst report on DBJP

Read the analyst report on DXKW

Read the analyst report on DBKO

Read the analyst report on EWY

Read the analyst report on EWJ

Read the analyst report on HEDJ

Read the analyst report on FEZ


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