Hedging Accomplishing Goals Well
These hedged strategies are accomplishing their goal of achieving those local market returns during periods of significant euro weakness. Note that over the last 1.25 years, when the euro moves really started accelerating downward, HEDJ not only kept pace with the local market return, which was up sharply, but actually provided more than 200 basis points (bps) of cumulative outperformance, even after fees.
Figure 2: Cumulative Performance
For current performance of HEDJ, visit the WisdomTree Europe Hedged Equity Fund page.
Is It Too Late to Adopt Hedged Strategies?
One question we are often asked about this currency-hedged European strategy: Has the euro move already been made, and is it too late to move toward a hedged approach?
Here I favor the positioning by Andre Perold and Evan Schulman’s paper from the Financial Analysts Journal in 1988, “The Free Lunch in Currency Hedging: Implications for Investment Policy and Performance Standards.” They wrote:
In this article we argue that it is better to formulate long-run investment policy in terms of hedged portfolios than unhedged portfolios. The key to our argument is that, from the perspective of long-run policy, investors should think of currency hedging as having zero expected return. Therein lies the free lunch. On average, currency hedging gives you substantial risk reduction at no loss of expected return. Our prescription does not say the prescient investor should not selectively lift a hedge, just that hedging should be the policy, and lifting the hedge an active investment decision.5
Getting Paid to Hedge
If you believe the euro is going to enter a strong rally, lift the hedge as an active decision. But you should realize taking euro risk is equally an active decision—when it is essentially a zero-cost option to get euro risk hedged. In fact, it is currently even better than a zero-cost option, as U.S. investors are being paid a small amount to hedge euro risk based on interest rate differentials to implement the euro hedge.6
Given these dynamics, euro-hedged strategies in many ways offer better long-run policy portfolios, and the unhedged strategies should only be used when an investor has a strong view the euro is going to appreciate.
We spoke with analyst Marc Chandler7, who believes 0.85 cents per euro is a very real possibility. I am not sure if that level will be reached, but I believe Marc makes just as strong a case as the analysts who say the U.S. dollar move is done and it can head back to $1.20 per euro.
Again, unless an investor has a clear idea the euro is on track to appreciate, the currency risk is just extra noise, and we’d suggest targeting the local equity market returns via hedged strategies.
1Source: Bloomberg, 12/31/14–4/24/15.
2Sources: WisdomTree, Bloomberg, 12/31/14–4/24/15.
3Sources: WisdomTree, Morningstar, 9/1/12–3/31/15
4Sources: WisdomTree, Bloomberg, 9/1/12–3/31/15.
5Andre F. Perold and Evan C. Schulman, “The Free Lunch in Currency Hedging: Implications for Investment Policy and Performance Standards,” Financial Analysts Journal, May‒June 1988.
6Sources: WisdomTree, Bloomberg, 3/31/15.
7Marc Chandler is Global Head of Currency Strategy at Brown Brothers Harriman.