Group Co.
Why Are You Not Currency Hedging Right Now?
Traders Magazine Online News, June 12, 2018
Intro
With technicals and fundamentals supporting a stronger dollar, is now the time to add some currency hedged exposure? There is a compelling strategic case to be made that investors should be fully currency hedged at all times. However, investors had few options until the June 2011 launch of the DWS suite of ETFs including DBEF, DBJP et al. These funds provided currency hedged exposure to various MSCI international benchmarks. Investor behavior around these relatively new tools suggest that most are playing the currency hedge tactically. Is it time?
Background
Investors flocked to international equities from 2000 onwards and were supported by a weakening dollar. In fact, from 12/31/2000 to 12/31/2010 the local total return performance for MSCI EAFE was just 1.86%, in total![1] However, the falling U.S. dollar (USD) over the same period meant that U.S. investors actually experienced total returns of 41.08%. That’s right, essentially all of the returns came from currency exposure and not from stocks. Very few investors realized those returns came from their short U.S. dollar trade, which for many was inadvertent, and certainly not from their selection of international equities. If currency can add this much to returns, then it could as easily subtract from performance in a reversal.
With this in mind, and both technical and fundamentals pointing to a long term reversal of the U.S. dollar weakness, the concept of launching currency hedged ETFs was born. Quantitative easing kept dollar rebound at bay for a couple of years until Japanese Abenomics devalued the yen. Suddenly, investors broadly witnessed the benefit of currency hedging. The MSCI Japan index returned 27.16% for 2013, however, the currency hedged MSCI Japan Index returned a staggering 52.98% for the same year, in line with local Japanese equity returns of 54.58%.
Market Timing
Many investors were able to participate in this divergence of returns by using hedge vehicles. However, the behavior indicates hedging was being used tactically. At the peak of the 2013-15 currency hedged inflows, 51.47% of large cap Japanese beta ETF exposure was hedged, a tactical reaction to the “Abenomics trade.” The Eurozone came second with 43.30% hedged at the peak during the European Central Bank’s (ECB’s) “whatever it takes” easing approach. Hedging of strategic allocations in broad developed markets only reached 15.05% of assets hedged, indicating that many investors are still not utilizing the benefits of hedging across their strategic allocations.
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