As overseas governments implement loose monetary policies and the U.S. dollar strengthens, currency-hedged exchange traded funds are becoming a popular, targeted play on international equities.
“You’re definitely seeing investment advisers become much more aware of the currency risk that they’re running,” Deutsche Bank’s Martin Kremenstein said in a MarketWatch article. “For the last 10 years, up until about a year ago, it was basically a free ride. The dollar was declining. You essentially always came out ahead out by not hedging. That paradigm has now ended.”
Most country-specific and international equity ETFs hold stocks denominated in their respective domestic currencies. If the U.S. dollar strengthens and the foreign currencies depreciate, the foreign equity ETF would take a hit when converting the weaker currency to the U.S. dollar.
“If investors are currently investing internationally, they are making a short bet on the U.S. dollar through that investment,” Kremenstein added. “If that isn’t exactly what they want to do, then they should consider using a currency-hedged product, either on its own or in conjunction with an unhedged product.”
The shifting investment environment is also stirring competition in the currency-hedged space. BlackRock’s iShares recently filed for its own line of ETFs that mitigate currency risk. [iShares Heats Up Competition in Currency-Hedged ETF Space]
The WisdomTree Japan Hedged Equity Fund (NYSEArca: DXJ) has been the most popular ETF this year as investors capitalized on the aggressive Bank of Japan monetary policies and a quickly depreciating yen. Deutsche Bank also offers its own Japan yen-hedged equity fund, the db X-trackers MSCI Japan Hedged Equity Fund (NYSEArca: DBJP). [Breaking Down the Two Largest Japan ETFs]
Looking ahead, the eventual Fed tapering and rise in interest rates would help support the U.S. dollar. The ICE dollar index, which tracks the greenback against a basket of six rival currencies, has gained 1.3% over the past year.
For more information on country-specific funds, visit our global ETFs category.
Max Chen contributed to this article.
Full disclosure: Tom Lydon’s clients own DXJ.