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Kremenstein: Hedge, Not Sell, Dollar Rally

Olly Ludwig


Martin Kremenstein, head of Deutsche Bank’s U.S. ETF operations, told IndexUniverse.com Managing Editor Olly Ludwig that while dollar weakness has been good for U.S. investors for more than a decade, that might not be the case going forward. Several currency-hedged ETFs now on the market that peel the currency variable right out of the equation—including five from Deutsche Bank—might be exactly what investors need to be protected from huge swings, such as the one on Brazil’s real that has left U.S. investors deep in the red in the past year.

Ludwig:Where did this idea of currency hedging originate?

Kremenstein: There are a lot of institutional investors, like pension funds, out there that are hedging out some or all of the currency exposure. It's not too much of a leap to think that if this is a good strategy for a large institution, it should be something that’s useful for the retail or midsized investor. That was really the spark that lit these products. And currency is a return driver that has been somewhat overlooked by investors.

Ludwig:I would say that’s the understatement of the new millennium.

Kremenstein: Funny you should mention the new millennium. Since the turn of the millennium, in the last 10 years or so, it’s been almost completely one-way traffic for the U.S. based investor. I think that’s why investors haven't concentrated too much on currency-hedged investing.

Ludwig: You're saying that because of the so-called secular decline of the dollar, why would you currency-hedge? But, suddenly, maybe that’s not going to be the case going forward?

Kremenstein: Yes, but more fundamentally, people don’t tend to look too closely at things that are helping them. They have just assumed that international equities have outperformed. They didn’t understand why it outperformed. If you look at, say, the EAFE Index, pretty much all the outperformance versus the S'P 500, since 2001, has really come from the decline of the dollar.

That’s great when it’s working for you. But, if it’s not, then you should look to try and neutralize that exposure.

Ludwig: Is there a reversion to the mean, a reversal of this decline of the dollar, that maybe investors should be more mindful of?

Kremenstein: Historically the dollar has moved in these seven- to 10-year bands. From 2001 to 2011 was just one such band. But I think our general view is that investors need to take account of currency moves. In the last 18 months to a year or so, there have been 5 percent, 6 percent, 7 percent moves in the dollar going in both directions. And if investors can catch those moves, then they can profit from that.

The problem with buying straight currency exposure is that you are taking capital away from the rest of your portfolio. You may catch the dollar, but you may have taken capital away from another asset class that could have done better. You may have taken capital away from foreign equities. Whereas, with these currency-hedged products, you can still stay invested in the foreign equities.

Ludwig: So let’s talk about the products. You have five of them, right? You have the broad emerging markets one. There's Canada. There's Japan. There's Brazil and there's one focused on the EAFE Index, yes?

Kremenstein: That’s correct.

Ludwig: OK. Clearly, the currency-hedge Brazil product looks awfully wise at the moment, considering what the Brazilian central bank has done to weaken the real. Its advantages are quite pronounced, and yet, in terms of assets, it hasn't gathered that many assets since its launch, which was when?

Kremenstein: Just a little over a year ago. We launched them on June 9, 2011.

Ludwig: So, these products, which look like pretty good tools for dealing with these currency moves, have yet to get really meaningful traction. I'm wondering if you might comment on what the you see as the inherent challenge here?

Kremenstein: I think there are a couple of things. To start, we probably haven't done the best job of getting the word out, and that’s something we’re working on. Every ETF provider has to explain to people why its products are different. You need to tell the story to the investor and to the investor’s advisor in the best way possible.

I also think there's a certain cognitive leap that the investor community has yet to make. If investors think the dollar is going to rally, their general view is to sell international assets rather than hedge out the exposure. If investors are worried about the euro, they're more likely to dump their European-denominated investments than they are to maintain the investment but use a product with a currency hedge. And that’s something that we need to overcome.

Ludwig: To be totally clear, your currency-hedged products essentially pull the currency variable off the table. So what you're getting is the returns in a given local market, whether it’s Brazil or Canada or Japan or whatever, right? So you're neither going to benefit nor be harmed by any movement in these particular currency crosses, right?

Kremenstein: That’s correct. We’re not providing the currency strategy. We’re merely giving the tool to the investor to run that strategy.

Ludwig: Now, you said that you were taking some responsibility for not promoting these products enough. So what does a really thoughtful, comprehensive, promotional campaign look like?

Kremenstein: We've been taking  a broad-based approach with these products, but it may be that in the longer term we need to do this in a more targeted way. We can tell the story based on commodity currencies:  There are commodity producers in Canada, Brazil and, to a certain extent, the emerging markets. And then you’ve got the commodity consumers which are Japan and mostly EAFE. That may be a very fertile furrow to plow. It’s certainly something that we’re looking at.

Ludwig: Yes. The only fund in this whole space that has really accumulated, shall we say, significant assets, is the WisdomTree strategy, DXJ, which is centered on Japan. And, at the risk of asking you to compare and contrast and possibly poke holes in your competitor’s products or promote your own, I'm wondering, how is an investor to look at DXJ versus DBJP?

Kremenstein: I think the key decision comes down to, what an investor is looking for – if they want the benchmark MSCI index, then DBJP provides that exposure? Do investors buy the dividend-weighting story, or do they prefer buying market exposure?

Ludwig: A straight market cap type approach vs. this exquisitely calibrated so-called fundamental type approach?

Kremenstein: Correct. The other thing is,  if you're running some kind of partial hedge, maybe say if you want to do a 50 percent hedge, then you want to be able to match off like funds. And, you could pair our Japan fund with the iShares Japan fund (EWJ). And the difference is basically the hedge on one.

Ludwig: So what’s going to cause the dam to break? I look at your products, and I am sort of puzzled they don't have more assets. I'm sure you're aware that we put out a currency report, where we publish a robust data set from MSCI that gives you the full breakdown.

Kremenstein: I read that report every week.

Ludwig: Well the Brazil thing seems like a very appetizing opportunity, right now. The numbers are just astonishing. If you have the local returns in Brazil, your returns have been around 5 percent in the past year, which isn't bad. But if you're in (EWZ), the unhedged Brazil fund, you're down 18 percent. That’s a huge difference. This is like a perfect textbook case of what investors should be interested in. And there's not even another currency-hedged Brazil ETF out there, is there?

Kremenstein: . That’s true, we have the only currency-hedged Brazil ETF, and it’s a compelling opportunity for investors.

Ludwig:Well, thanks for your time, Martin. I really appreciate it. Bye.



The author held no positions in the securities mentioned.

Contact Olly Ludwig at oludwig@indexuniverse.com

The DB ETFs referenced in the story include (DBJP), (DBEF), (DBBR), (DBEM) and (DBCN)
















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