Loving the Strong Dollar, Currency Hedged ETFs Shine

Over the past 90 days, the PowerShares DB US Dollar Index Bullish Fund (NYSEArca: UUP) is up 5.4%. That alone is impressive, but making that performance all the more memorable is that UUP has offered better than double the returns of the S&P 500 over the same period.

There is a long-standing debate that a strong U.S. dollar can crimp certain corners of the equity market, but the evolution of currency hedged exchange traded funds has given investors myriad options for remaining long global equities while simultaneously exploiting dollar strength.

Deutsche Asset & Wealth Management, the ETF issuing unit of Deutsche Bank (NYSE: DB), is one of the largest purveyors of U.S.-listed currency hedged ETFs, a good business to be in a time of dollar strength and faltering currencies throughout much of the ex-U.S. developed world.

“Currency hedged ETFs have been a cornerstone of our business since we first launched the funds three and a half years ago,” said Luke Oliver, Head of Capital Markets for Passive Investments at Deutsche Asset & Wealth Management, in an interview with ETF Trends from the Morningstar ETF Conference in Chicago.

Prior to the evolution and subsequent increased appeal of currency hedged ETFs, many investors were programmed to believe that by holding stocks or ETFs over long time frames, the impact of currency fluctuations could be mitigated. That strategy worked when the dollar was weak, but after years of declining, the greenback could be entering a period of prolonged strength.

Oliver points out that from 2000 through 2013, the MSCI EAFE Index gained 45%, but when stripping out the effect of the weak dollar, the index was essentially flat.

“A lot of returns have come from a weak dollar, but what happens to investors as the dollar rises?,” said Oliver. “The dollar story has changed. It has had a nice recovery with quantitative easing ending.”

The end of QE combined with accommodative monetary policies from the Bank of Japan and the European Central Bank, among others, helped send $1 billion into Deutsche AWM currency hedged ETFs last year, a total that has already been eclipsed this year as investors have put $1.3 billion to work in the firm’s ETFS, including the Deutsche X-Trackers MSCI Europe Hedged Equity ETF (NYSEArca: DBEU)  and the DeutscheX-trackers MSCI EAFE Hedged Equity Fund (NYSEArca: DBEF). [Currency Hedging Working for This ETF]

Both DBEF and DBEU have benefited from what Oliver calls perfect storm-type for scenarios. DBEU is not a dedicated Eurozone ETF, but the fund allocates about 44% of its combined weight to Eurozone members France, Germany, the Netherlands, Spain and Italy. Another 14.3% goes to Swiss stocks, worth noting because the Swiss franc is pegged to the euro. To top it off, DBEU has a 27.6% weight to British stocks and the pound has, until the past few days, been sliding. [A Shining Europe ETF]

Those that doubt the efficacy of currency hedging should consider the following: DBEU is up about 5% this year while the unhedged Vanguard FTSE Europe ETF (NYSEArca: VGK) is in the red. Investors have acknowledged DBEU’s advantages. Still 10 days shy of its first anniversary, the ETF has $309.4 million in assets under management.