Note: This article is part of the ETF Trends Strategist Channel
By Clayton Fresk
Over the past few years, a very popular trend in the ETF industry was the advent of currency-hedged ETFs. Investors were now able to strip out foreign currency risk by being long the US Dollar versus the inherent currency risk in a traditional non-US ETF.
Given the plethora of central bank policies coming to the forefront and the effect these action are having on currencies around the world, some investors may want to shun that currency risk altogether – whether in US dollars or other currencies -and rather have it tied to some sort of real asset. However, given asset allocation constraints, getting access to said real asset exposure usually has to come at the expense of reducing exposure elsewhere.
However, recently a couple new ETFs came to market that look to solve the real asset exposure issue without the need to reduce exposure elsewhere.
REX ETFs have issued two ETFs that pair long equity exposure with a corresponding long exposure to Gold:
- GHS – REX Gold Hedged S&P 500 ETF
- GHE – Rex Gold Hedged FTSE Emerging Markets ETF
As mentioned, the gold exposure is in tandem with the underlying equity exposure (via gold futures). So rather than in a traditional asset allocation case where an investor would have to reduce exposure to an asset class, say equities, to add a long position in Gold, these ETFs allow for a gold overlay on that exposure as to not have to reduce exposure elsewhere.
As such, investors can maintain a more traditional asset allocation while simultaneously hedging the currency risk inherent in said positions versus Gold.
In the following, I will break down the two ETFs a bit more:
S&P 500 Gold Hedged
Gold hedging an S&P 500 portfolio is not a brand new idea in ETF/ETN land. UBS offers an ETN through the ETRACS brand (SPGH) which also looks to offer similar exposure as does GHS. However, a few characteristics lead me to favor the new REX offering.
First, the REX offering tracks the S&P 500 Dynamic Gold Hedged Index, whereas the ETRACS offering tracks the S&P 500 Gold Hedged Index. Dynamic is a key differentiating trait. The dynamic index rebalances monthly in line with the gold futures roll. However, a more important trait of the dynamic index, as taken from the S&P index methodology, is as follows:
The index is also rebalanced to equalize notional exposure to equity and gold after the close of the first business day of September, if the difference between the values of the gold futures exposure and the equity exposure is more than 10% above or below the value of the index as of the last rebalancing, or if the sum of the equity return and gold futures return since the last rebalancing is more than 20% or below -20%. Source: http://us.spindices.com/indices/strategy/sp-500-dynamic-gold-hedged-index
To summarize, the index will normalize back to a 1:1 exposure once the gold and/or equity exposure gets too far unbalanced. Below is a chart of the relative performance of the dynamic vs ‘non-dynamic’ index since incept in 1998.
The dynamic index has led to about a +21% differential over this period. You can also see where the benefit came into play in particular during the 2008 bear market.
A couple other differentiating points between GHS and SPGH are:
- GHS is an ETF, whereas SPGH is an ETN. GHS will not have the additional counterparty risk inherent in the ETN structure, along with the other differentiating factors that favor ETFs.
- GHS has a (gross) expense ratio of 0.48%, whereas SPGH runs at 0.85%.
FTSE Emerging Market Gold Hedged
As I mentioned previously, the advent of currency-hedged ETFs is not a new phenomenon. However, these ETFs will naturally hedge the currency exposure back to the US Dollar (i.e., long the US Dollar and short the currency or currency basket). This may or may not be advantageous given the increasing currency ‘manipulation’ occurring around the globe. As mentioned the REX offering allows for a Gold overlay, which takes the US Dollar out of the equation relative to other currency-hedged offerings. Since the underlying equity exposure itself is not currency hedged, an investor will be long both EM currency and gold exposure.
Gold: Asset Class or Currency?
One question an investor needs to ask when analyzing the new REX offerings is whether Gold should be treated as an asset class or a currency. In a traditional allocation where other asset class exposure must be reduced to accommodate a gold exposure, gold is hence treated as its own asset class. In the REX structure where gold exposure is overlaid onto other existing exposure (in this case S&P 500 or Emerging Markets), it is essentially treated more as a currency than a separate asset class. In the overlay case, the diversifying effects of gold as an asset class are mitigated since other exposures remain. However, the tradeoff to this is there are diversifying effects versus the currency exposure inherent in an existing asset allocation. While I am not here to argue against the benefits of gold as a separate asset class, there may be room in an allocation for both gold exposures, especially in this time of central bank currency manipulation.
Clayton Fresk is a Portfolio Manager at Stadion Money Management, a participant in the ETF Strategist Channel.
[related_stories]The above constitutes the personal, professional opinion of Clayton Fresk, CFA, and does not necessarily reflect the views of Stadion Money Management LLC. References to specific securities or market indexes are not intended as specific investment advice.