Tue. May 24th, 2022


Currency-hedged exchange-traded funds remain firmly in favor in the US – despite exorbitant returns in recent years.

The largest currency-hedged ETFs in the US all outperformed their unencumbered equivalents last year, helped by the strength of the dollar, which rose 6.7 percent against a basket of six other developed world currencies, as measured by the DXY index.

Yet the collective assets of US-listed currency-hedged ETFs – which neutralize the movement in foreign currencies against the dollar while still providing exposure to overseas assets – ended last year at just $ 16.9 billion, according to Bloomberg data.

This score is nearly three-quarters lower from the year-end high of $ 61.3 billion in 2015, despite the fact that the broader U.S. ETF industry has more than tripled in size since then, according to figures from ETFGI.

The popularity of currency-hedged ETFs exploded in the U.S. in 2014 and 2015 when the DXY index rose 23 percent, a significant rise for a developed world currency, in two years, eroding returns for unsecured U.S. investors.

The dollar’s gains were particularly sharp against the Japanese yen, which fell after the government of then-Prime Minister Shinzo Abe pursued an aggressive policy of quantitative easing.

Line chart of assets of US listed currency hedged ETFs ($ billion) showing no yen for hedging

“Currency hedging took hold after Abe was elected in Japan. Abe was like the [latter-day US Federal Reserve] on steroids, ”says Eric Balchunas, senior ETF analyst at Bloomberg Intelligence, with WisdomTree’s Japan Hedged Equity Fund (DXJ) a leading beneficiary.

“Then currency hedging started in Europe. They did 20-30 better [percentage] points, ”he added.

“WisdomTree shot up the league tables. Every asset manager that has had an international equity ETF has launched a currency-hedged alternative to give investors a choice, ”says Todd Rosenbluth, Head of ETF and Mutual Fund Research at CFRA Research.

“They are positioned as a key international stock exchange to reduce the risk of currency fluctuations, let alone the potential to take advantage of currency fluctuations.”

However, the decline in the format was almost as rapid, as a fall in the dollar index from a high of 103.3 in December 2016 to 89.4 in early January 2021 eroded returns and meant that dollar-based investors was better then to use unscrewed vehicles to gain access to European access. and Japanese equities.

Last year, however, the dollar rose again, with the DXY index rising 6.7 percent, making hedged ETFs shine again.

Index Chart US Dollar Index (DXY) Line Chart

The iShares Currency Hedged MSCI EAFE ETF (HEFA), for example, at $ 3.4 billion, the largest hedged fund delivered 19.4 percent, comfortably ahead of the 11.2 percent gain of iShares’ MSCI EAFE ETF (EFA), its unbridled sister product.

Three hedged eurozone equities products, Xtrackers’ MSCI Europe Hedged Equity ETF (DBEU), WisdomTree’s Europe Hedged Equity Fund (HEDJ) and iShares’ currency hedged MSCI Eurosone (HEZU) all returned between 23 and 24 percent, while their unscrupulous counterparts the iShares MSCI Eurozone ETF (EZU) and the Vanguard European Stock Index Fund ETF (VGK), made 13.6 percent and 16.4 percent, respectively.

Despite these successes, however, the 26.9 percent rise in the sector’s assets last year lagged behind the rate of asset growth seen by U.S.-listed ETFs in general, and was an indication of very limited inflows.

“About 70-80 percent of the money remained. Then [currency-hedging] started working again and nobody cared, ”said Balchunas.

“There are probably some investors who will use them, but not the mass market. They are no longer in currency hedging. [The ETFs] still have more assets than they had before Abe [in 2012], but [it’s a case of] rags to riches to barely above rags, ”he added.

Rosenbluth believed investors were “burned” by the poor performance of currency-hedged funds in recent years.

“They are less likely to come back for a second bite of the apple. “They touched something that was too hot, they burned and now they are hesitant to do it again.”

In addition, Rosenbluth said many of the currency-hedged funds launched at the height of the boom have since disappeared due to a lack of demand.

Even WisdomTree, the driver that propelled the original boom, has largely moved on, Rosenbluth argued.

“[WisdomTree] was such a big proponent of currency hedging. That was where they put their marketing dollars, ”he said, but the New York-based issuer has since diversified into areas such as thematic ETFs, cryptocurrencies and leveraged and reverse products.

“I do not think educating investors about the benefits of currency hedging is that common,” Rosenbluth added.

Can the strategy make another comeback?

Andrew Jamieson, global head of ETF product at Citi, said there was a “compelling argument to buy [say] a currency-hedged Japanese index product people would “, but compared to the mid-2010s, ETF investors were now” spoiled for choice “.

“We have battery technology, clean energy, online gambling, meme stocks, crypto-ETFs, you name it. That’s what captures the imagination. [of retail investors]. That’s the reason [currency-hedged] products are not the titans they used to be. ”

Balchunas said that once investment strategies have slipped out of favor, it can be difficult to regain widespread acceptance.

“Once something stops working and people move out of it, and then it starts working again, can you get investors back? What we found with currency hedging is not in that case. “

Rosenbluth also saw little chance of a large-scale return. U.S. retail investors “are often home-biased and like to follow the simple route, and probably do not have the confidence to predict currency movements,” he said.

“They are too comfortable with the devil they know, rather than learning more about the devil they do not know.”

For a return to happen, “we will have to see a long period of performance,” he said.

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