Time to Hedge Euro Risk?
By The ETF Professor, Benzinga Staff Writer | January 31, 2013 8:05 AM EST
Following a surge for European equities last year, some investors may be left thinking everything is fine and dandy with the common currency used by 17 nations. After all, at the ETF level, it was those funds that assume currency risk that were inflow leaders in 2012.
A case can be made that things are improving in the Eurozone, but that can be countered with the notion that the euro is not yet out of the wood. That means investors should consider a hedge to currency risk when evaluating European equities and the corresponding ETFs.
"I believe both the euro and the U.S. dollar have their fair share of potential weaknesses," said WisdomTree Research Director Jeremy Schwartz in a new research note. "Ultimately, the situation begs the question: Should investors trying to capture the relatively low prices of European stocks take on additional euro risk—namely positioning themselves so that their investments may decline from a weakening euro compared to the U.S. dollar—in doing so?"
Some of the largest Europe-focused ETFs have continued to impress in 2013 after surging last year. For example, the iShares S&P Europe 350 Index Fund (NYSE: IEV) has gained 5.1 percent year-to-date while the SPDR EURO STOXX 50 (NYSE: FEZ) is up about 4.9 percent. The rub with both funds is that each leaves investors vulnerable to potential euro weakness.
"It is widely understood that currency performance can add significant volatility to international equity returns, but the difficult question regards whether investors receive compensation, i.e., a potential increase in their returns, for taking on this additional risk," Schwartz said in the note.
Investors that want to embrace the attractive valuations still being offered by some European stocks while skirting currency risk have options, including the WisdomTree Europe Hedged Equity Fund (NYSE: HEDJ). In rough terms, HEDJ is the hedged euro equivalent of the wildly popular WisdomTree Japan Hedged Equity Fund (NYSE: DXJ).
HEDJ is "designed to have higher returns than an equivalent non-currency hedged investment when the value of the U.S. dollar is increasing relative to the value of the euro, and lower returns when the U.S. dollar declines against the euro," according to WisdomTree.
As DXJ does with Japan, HEDJ screens possible constituents to ensure the fund's holdings are not heavily dependent on the Eurozone for the bulk of their revenue.
The emphasis on trimming currency volatility has not hampered HEDJ's returns. WisdomTree altered the ETF's composition to focus solely on European dividend payers that derive the bulk of their sales outside the Eurozone in August 2012. Since August 30, the ETF has soared almost 17 percent.
Investors have bought into HEDJ's new look. On August 21, the ETF had just $15.3 million in assets under management. As of January 29, that total had surged to $39.4 million, indicating that some investors are heeding Schwartz's advice to hedge their euro exposure.
"Bottom line: Investors should consider how much conviction they have in the potential performance of the euro against the U.S. dollar—and if the answer is that they have no idea as to its future direction, which I suspect is the case for many, they ought to consider hedging that risk, if they are truly trying to capture the equity opportunity," said Schwartz.
For more on ETFs, click here.
(c) 2013 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.
Join the Conversation
- New Zealand Economy Benefits From Australia's Big Investments; Kiwi Down After RNBZ Comments
- ETF Outlook for Thursday, January 2 (FEZ, FXI, SPY, XHB)
- January Second Trading: Always Interesting
- 13 Things Investors Learned In 2013 - Part II
- Are Diversity and Quality the Way to Profit from the Rebound in Gold and Coal?
- Target’s ‘Surprise Doorbusters’ Black Friday 2014 Deals On TV Sets, Entertainment Centres, DVD Players And More
- IKEA Black Friday 2014 Ad Includes Discounts On Home Furnishings, Appliances, Kitchen Designs, Beds, Sofas, Mattresses And Toys
- T-Mobile’s Black Friday 2014 Deals On Apple iPhone 6, Samsung Galaxy Note 4/Edge, Nexus 6, HTC One M8, LG G3, iPad Air 2 And Mini 3
- 5 Proofs Russia is Geared-Up for Shooting War with U.S. and Can Win Future Nuclear Showdown
- Black Friday And Cyber Monday Sale 2014: AT&T's Cricket Wireless Offers Discounts On Lumia 1320, Galaxy S5, S4 And HTC Desire 510
- ISIS Kidnaps Iraqi Defence Minister’s Family, Executes Female Parliament Candidates
- ISIS Drug Transit From Afghanistan To Europe Confirmed By Russia: Money Goes Into Terror Funding And In New Recruitments