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Not Surprising: Currency Hedging Makes a Difference in Emerging Markets

Emerging markets currencies are getting plenty of attention these days and most of it is bad. Put the phrased “emerging markets currencies contagion” into Google and a tidy 13.5 million results are returned in a third of a second.

“Contagion” may be overused as a way of describing the current state of affairs with developing world currencies, but it is not inaccurate. The WisdomTree Emerging Currency Strategy Fund (CEW) is off 2.3% in the past month currencies across the emerging world have stumbled on renewed fears of Federal Reserve tapering. [Emerging Currencies Tumble]

If there is a glimmer of hope for investors looking to grab emerging markets bargains it is this: The hedged-currency theme that rose to acclaim last year due in large to Japan ETFs works with emerging markets funds. That is to say the db X-trackers MSCI Emerging Markets Hedged Equity Fund (DBEM) has been noticeably less bad in recent weeks than its unhedged rivals, the iShares MSCI Emerging Markets ETF (EEM) and the Vanguard FTSE Emerging Markets ETF (VWO) .

Here is a one–month chart of that trio. Obviously, there is nothing to write home about there, but DBEM has clearly outperformed/been less offensive than EEM and VWO.

DBEM may get a bum rap for being thinly traded and small ($22.4 million in assets under management), but less bad is the new black with emerging markets, at least for the time being. Plus, DBEM has slightly outpaced its unhedged rivals over the past year, a time in which the Chinese yuan and South Korean won have two of the strongest emerging currencies. China and South Korea combine for 37.2% of DBEM’s weight.

While those are DBEM’s largest country weights, the ETF’s Fragile Five, or BIITS, exposure should not be overlooked. Brazil, India, Indonesia, Turkey and South Africa, the BIITS/Fragile Five countries, are home to some of most downtrodden currencies in the developing world.

That is a drag on a fund such as EEM which allocates about 28% of its weight to the Fragile Five. Currency fragility in the BIITS quartet is less of a concern for DBEM not only because it is a hedged product, but also because only two BIITS nations – Brazil and India – are found among the ETF’s top-nine country weights and combine for just 17% of DBEM’s total weight. [Risks Aplenty in Indonesia]

DBEM Top Country Weights

Tom Lydon’s clients own shares of EEM.