Deutsche Bank Delivers Currency Hedged ETFs
The U.S. dollar has been in a weak cycle for the past six
years. This is a long enough period for many of us to forget what can happen
when and if this long term trend reverses.
Many U.S. investors have diversified their portfolios by
adding international markets and ETFs over this long weak dollar period and
have benefitted greatly by stronger non-dollar currencies. But now, and
shockingly to many investors, the previous weak dollar trend may be changing
course and moving higher. This can significantly upset diversification efforts
and portfolio performance as exposure to weaker currencies negatively impacts
common holdings of international ETFs including popular examples including EAFE
(EFA), Emerging Markets (EEM) and Europe (IEV) among others.
The weak dollar trend has lasted long enough to become
embedded in diversified portfolio models used by financial advisors as many
have accepted typical non-dollar ETFs as a common investment inclusion for most
diversified portfolios.
But things are changing.
By way of background, it was common that currency markets were
some the best trending markets as trends once begun remained durable and
long-lasting. This was an accepted fact by forex traders during the 80s and
90s. My own experience verified this since I used qualified and well-known
third party advisors to position client assets in commodities and currency
markets. This was done with great success during that period.
A new player entered the scene in the early 2000s—the U.S. Fed
and other central banks.
In the Deutsche Bank chart below you can readily verify both
long term currency trends and U.S. dollar weakness occasioned by U.S. Fed
policies post the dotcom bubble and financial market crisis which weakened the
dollar. Naturally other forces like interest rate differentials and varying
economic conditions play a role in currency levels.
The previous weak dollar trend made overseas investing more
lucrative and an effective tool enhancing portfolio diversification, so much so
that every financial advisors asset allocation computer model reflected
allocations overseas. But the dollar is now in rally mode as new so-called
“currency wars” are becoming common involving developed countries bent on
defending trade advantages. Further, the U.S. economy is stronger than its
peers which is reflected in currency differentials.
Investors with previously accepted portfolio global diversification
models have abruptly felt the pain over the past two months as the dollar has
soared. In some cases, currency movements alone wiped out all gains from the
linked equity index. The Deutsche Bank white paper reflects effects of currency
changes below:
Naturally, this development wasn’t lost on Wall Street new
product engineers, especially those at Deutsche Bank and to a lesser extent
Wisdom Tree which launched popular (DXJ and HEDJ). In Europe, the company had already
created ETFs to deal with currency issues for their overseas clients. Now Deutsche
Bank has issued 11 currency hedged ETFs linked to popular MSCI indexes designed
for U.S. investors. Some of these 11 are still slowly gaining AUM while others
have seen AUM exploding higher quickly as there was a ready audience anxious
for these products. No doubt others will be offered in due course.
Without going over all the products let’s compare the most
commonly used unhedged MSCI portfolio ETFs against the hedged MSCI Deutsche
Bank produces.
These ETFs alone show the need for these products
especially if strong dollar trends continue. DB achieves their goals by hedging
currency exposure by 100% using one month currency rollover contracts.
But what if the developing strong dollar trend doesn’t
last? In the first place an investor
would still have exposure to the index. A Deutsche Bank white paper asserts:
“We expect that utilization of currency-hedged ETFs has only just begun. Most
currency strategists are forecasting multi-year continued strength of the U.S.
dollar, a view that we share at Deutsche Asset & Wealth Management. We
believe the U.S. dollar has entered a secular cycle of strength—and
historically, these cycles have persisted for several years.” And they add: “Investors with no opinion on
the direction of exchange rates should consider remaining ‘currency neutral’ by
hedging currency exposure.”
The white paper [8] [pdf]
asserts DB’s fundamental assertion that, “The U.S.
dollar’s growing strength is a function of divergence—divergence in the growth
of different global economies, and the resulting divergence in global
central-bank policies. The United States is in a more advanced stage of
recovery than the Eurozone or Japan, priming the U.S. Federal Reserve Board
(Fed) for monetary tightening even as the rest of the world continues broadly
expansive measures. This policy divergence will have a meaningful and long-term
impact on the strength of the U.S. dollar.”
Dave Fry is founder and publisher of ETF Digest
and has been covering U.S. and global ETFs since 2001.
He is the author of "Create Your own ETF
Hedge Fund: A Do-It-Yourself Strategy for Private Wealth Management"
published by Wiley Finance and "The Best ETFs: U.S. Equities, A Companion
Guide to Building Your ETF Portfolio"
