How Did This International Strategy Beat 97% of Its Peers? by by Jeremy Schwartz, Director of Research, The WindomTree Blog
A big story of the last two years has been the strength of the U.S. dollar and the change in central bank policy prescriptions that led to it. This move has caused strong reverberations across foreign stock funds that are exposed to foreign currency risk.
When allocating to foreign stocks, investors typically must take on currency risk in addition to the local equity exposure. Recently, the by-product of this “currency bet” has detracted from the performance of traditional international funds—the vast majority of which do not hedge currencies. To address this, WisdomTree launched a broad-based international currency-hedged strategy in 2014 that gives exposure across the major developed world countries but hedges out the currency impact. That hedge is leading to dramatic performance differentials versus the large category of foreign open-ended funds and exchange-traded funds (ETFs).
How Strong Are Currency Headwinds?
There are more than 1,500 open-ended funds and ETFs in the foreign large-cap, large value and large-cap growth categories, according to Morningstar. Below we showcase how the WisdomTree International Hedged Dividend Growth Fund (IHDG) has beaten 97% of its 1,515 peers since its inception. We contrast this with the MSCI EAFE Index and the FTSE Developed ex North American Index, which have only beaten 45% and 47% of this peer group, respectively. Both of these indexes have exposure to foreign currency risk, which shows how dramatic currency headwind can be.
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The strong relative returns of IHDG versus the peer group show how currency has become a prime driver of relative performance when investing internationally.1
IHDG Beats 97% of Foreign Large-Cap Funds
Percentage of Peers Beaten in MorningStar Category as of December 31, 2014
Average Annual Returns as of 12/31/2014
Portfolio Characteristics of IHDG
IHDG has a stock selection focus driven by three factors: high return on equity (ROE) and high return on assets (ROA), which are two measures associated with “quality,” and earnings growth expectations.
• As a result of these screens, the methodologies tend to be concentrated in Consumer Staples, Consumer Discretionary, Health Care and Industrials. The two consumer sectors are the largest two sectors in IHDG and combine to represent more than a third of the ETF. Combined with Health Care and Industrials, which each represent more than 15% of the Fund, these four sectors make up over 60% of IHDG. The Fund’s three lowest exposures on a sector basis are to Utilities, Financials and Energy. Utilities and Financials are highly leveraged sectors, and the screen for ROA reduces their exposure.
• An important element to consider is the ultimate cost of hedging, which can be estimated as the weighted average difference in short-term interest rates relative to the United States. For IHDG, this figure is approximately 0.2%, a relatively small cost to hedge these developed international currencies. The four biggest exposures are to the euro (more than a third of the ETF), British pound (almost 20%), Swiss franc (13%) and Japanese yen (9%) as of December 31, 2014.
WisdomTree believes currency-hedged investment strategies are growing in prominence due to shifting policy winds among global central banks. We believe that IHDG represents a potentially beneficial marriage of growth and quality characteristics with this added currency-hedged feature. This type of exposure represents to us an attractive holding for core allocations to developed international stocks.
1All data is as of 12/31/14.
Important Risks Related to this Article
All holdings and sectors are subject to change.
There are risks associated with investing, including possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. To the extent the Fund invests a significant portion of its assets in the securities of companies in a single country or region, it is likely to be impacted by the events or conditions affecting that country or region. Dividends are not guaranteed, and a company currently paying dividends may cease paying dividends at any time.
Investments in currency involve additional special risks, such as credit risk and interest rate fluctuations. Derivative investments can be volatile, and these investments may be less liquid than other securities, and more sensitive to the effects of varied economic conditions. As this Fund can have a high concentration in some issuers, the Fund can be adversely impacted by changes affecting those issuers. The Fund invests in the securities included in, or representative of, its Index regardless of their investment merit, and the Fund does not attempt to outperform its Index or take defensive positions in declining markets. Due to the investment strategy of this Fund, it may make higher capital gain distributions than other ETFs. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.