There have been two very important trends in the asset management and exchange-traded fund (ETF) industry WisdomTree has pioneered over the last decade.
First was the rise of smart beta or factor exposures to deliver strategic equity allocations designed to improve risk-adjusted returns by rebalancing funds based on the concept of relative valuations. Second was the use of currency-hedged equities to more directly target the local market returns while neutralizing currency exposure.
WisdomTree believes a third new category incorporates important elements of both trends by providing unique U.S. equity factor exposures related to currency sensitivity.
Increasingly, views on the U.S. dollar have motivated a desire for international equities to be currency hedged, especially for exposures in Europe and Japan. Japan, a largely export-driven market with a negative correlation between its equities and its currency (the yen), has demonstrated how important currency could be to the performance of its stock market. As the yen weakened in 2013 and 2014, Japan equities1 soared due to Japan’s improving export competitiveness and rising profits.
Currency Factor in U.S. Equities
But currency moves are not just important to foreign markets. In the U.S, we have also seen U.S. dollar strength impact stocks that are exposed to sales in foreign markets. It is widely known that a significant percentage of the revenues of U.S. companies in the S&P 500 Index come from abroad. These companies have reported large currency headwinds as part of their earnings statements this year. This can be seen in the relative performance of the S&P 500 Index against European2 and Japanese exporters3, who have benefited from the yen and euro, respectively, weakening against the U.S. dollar.
In the chart below, we look at the 12 months ending June 30, 2015, to indicate a period when the U.S. dollar strengthened significantly against both the euro and the yen.
Impact of U.S. Dollar Shown in European and Japanese Exporters Outperforming the S&P 500 Index
• Europe and Japan Exporters Perform Strongly: We can see that as the yen and the euro depreciated against the U.S. dollar, both Japan exporters and Europe exporters outperformed the S&P 500 Index.