It’s Clear: Yen Hedged Is the Way to Go With Japan ETFs

Amid a recent slump by the Japanese yen that has some foreign currency market experts speculating that the Bank of Japan will intervene to support the flailing currency, some astute equity investors are apt to reconsider the currency hedge versus unhedged debate as it pertains to Japanese stocks.

On a year-to-date basis as of April 29, it’s really not a debate at all. The WisdomTree Japan Hedged Equity ETF (DXJ), the leading exchange traded fund hedging yen/dollar exposure, was up 22.7%, beating the unhedged MSCI Japan Index by a margin of better than 4-to-1.

The advantages of hedging yen/dollar currency fluctuations are also evident over shorter time frames. For example, over the 20 days ending April 29, DXJ rose 0.6%. Doesn’t sound like much, but it’s stellar in comparison to the 3.6% shed by the unhedged MSCI Japan Index. Remember, that timeframe included not only an overt slump by the yen but dollar strength on speculation that the Federal Reserve may be forced to unleash another interest rate hike this year.

DXJ Dilemma Solved

All right, so the aforementioned periods, essentially four months and four trading weeks, are short and not long enough for investors to get an adequate handle on the pros and cons of any currency-hedged ETF. The good news for investors who want to currency hedge is that DXJ has serious long-term credentials.

“While larger forces (e.g. central banks) may ultimately decide the near-term trajectory of the Yen, we thought it helpful to provide some statistical context to Japan hedged vs. unhedged equity performance as well as solutions available… Japan hedged has been a more successful investing endeavor over the last 30 years,” noted Todd Sohn of Strategas Securities.

While Sohn advocates in favor of a half-hedged/half-unhedged strategy when it comes to accessing Japanese stocks, the point that hedging worked in investors’ favor over the past 30 years refutes the claim by currency critics who assert that long-term market participants don’t need to pay up for currency hedging and that unhedged strategies are “just fine” over the long haul.

Not really. The 30-year advantage of currency hedging Japanese stocks is 147 basis points over embracing the asset class in pure dollar terms, but data cited by Sohn indicate that the advantage has been increasing in recent years. Over the past decade, the advantage of hedging yen currency risk was about 460 basis points over an unhedged strategy. Over the past five years, yen hedging beat an unhedged basket by better than 2-to-1.

Plus, as Sohn noted, DXJ is the best on a year-to-date basis of the major Japan-hedged ETFs available to U.S. investors.

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