Currency Hedged ETFs: Lessons From Japan

Over the past two years, currency hedged exchange traded funds, those ETFs that seek to reduce investors’ currency risk by pairing short positions in a particular foreign currency against the U.S. dollar while being long equities, have increased in notoriety and number.

It is not surprising given Japanese Prime Minister Shinzo Abe’s efforts to stimulate the world’s third-largest economy by significant weakening of the yen. By many accounts, Abenomics is working as the yen resides near six-year lows against the dollar. [Investors Miss Out on Yen’s Slide]

Abenomics has taught investors that currency hedged ETFs do in fact work, but there is the matter of timing. Over the past two years, the WisdomTree Japan Hedged Equity Fund (NYSEArca: DXJ) has surged 72.7% compared to 33.8% for the unhedged iShares MSCI Japan ETF (NYSEArca: EWJ).

DXJ dominance over EWJ has helped make the former a $10.4 billion ETF and spurred the introduction of more currency hedged ETFs. “There are now 27 currency-hedged equity ETFs for six different countries. Twenty have launched since Abe began, seven for Japan,” reports Lewis Braham for Barron’s.

Not surprisingly, advisors, money managers and investors are left wondering if all currency hedged ETFs can replicate DXJ’s success and are worth owning. Importantly, as Barron’s notes, “the U.S. is winding down its stimulus program, which will strengthen the dollar.” [Dollar ETFs in Style]

While the Federal Reserve is winding down quantitative easing, the European Central Bank is just getting going on its own stimulus efforts, weakening the euro in the process. The CurrencyShares Euro Currency Trust (NYSEArca: FXE) is hovering near a 52-weak low, but that is good news for the WisdomTree Europe Hedged Equity Fund (NYSEArca: HEDJ).

By employing a euro hedge with an emphasis on dividend-paying exporters based in Eurozone countries, HEDJ is up 5.1% this year compared to a meager 0.4% gain for the Vanguard FTSE Europe ETF (NYSEArca: VGK), which neither hedges currency risk nor focuses exclusively on Eurozone companies. HEDJ’s advantage over VGK provides another DXJ/EWJ type of lesson. Investors have listened as HEDJ has more than doubled in size since April. [Hedged Euro ETF Shines After ECB News]

The Deutsche X-Trackers MSCI Europe Hedged Equity ETF (NYSEArca: DBEU) is another example of currency hedged ETF that has been working. DBEU is a currency hedged alternative to the diversified Europe ETFs so many investors have embraced in that it features ample U.K. and Switzerland exposure along with plenty of Eurozone allocations.