by: Lawrence Hamtil of Fortune Financial
In February, we touched on the fad of currency-hedged ETFs, and how currency-hedging your foreign equity exposure can actually hurt diversification in your portfolio. This topic couldn’t be more relevant now given the turmoil in the markets caused by a surging yen, currently at 17 month highs, despite the Bank of Japan’s Herculean efforts to weaken the yen. In fact, sinceadopting negative interest rates (known as “NIRP”), on January 29th of this year, the yen (as measured by its CurrencyShares equivalent, FXY) has surged almost 10%!
You can see from the chart below, courtesy of Google Finance, that since the announcement of negative interest rates, the yen has surged (blue line, FXY), while the currency-hedged Japanese equity ETF, HEWJ (red line), has dropped about 11%, while the garden-variety non-hedged Japanese equity ETF, EWJ, is down a modest 1.83%:
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Naturally, since the yen had been in steady decline for much of the last few years (FXY dropped 34% from 2011-2014), many investors expected yen weakness to continue, and they spent much of 2015 pouring money into the currency-hedged ETF, HEWJ, which goes long Japanese equities while being more or less short the yen (flow data courtesy of ETF.com):
While it’s true that both iShares funds took in money last year, the inflows have to be put in perspective. Morningstar reports that EWJ has about $16 billion in assets, so its asset base grew roughly 25%. However, the hedged ETF, HEWJ, currently has net assets of about $546 million, so the fund, which began in January 2014, expanded its asset base at least a couple hundred times over.
Naturally, the “hot” money that bet on the “obvious” trade of a weaker yen was quick to leave the money once the yen’s ascent gained momentum after the announcement of negative interest rates failed to arrest the ascent of the yen:
Obviously, both funds have lost assets since the NIRP announcement on January 29th, but the hedged ETF has hemorrhaged a far greater percentage of its assets compared to the unhedged version.
The point I’m trying to make is that oftentimes in finance, the “obvious” or “sure-fire” trades rarely work out as they are supposed to work. In fact, one of the most interesting developments since the financial crisis has been the tendency of markets to do exactly the opposite of what policymakers have intended.
There will always exist the temptation to overreact to policy announcements or external forces beyond our control, tempting us to change our allocations or alter our risk profiles. After years of ZIRP, NIRP, QE, and all the rest, it’s evident that even the Ph.D.s who run the central banks can’t figure out which way their currencies are going, let alone control their direction. For that reason, it’s generally safer just to keep your global equity portfolio diversified and unhedged.
Disclosure: Neither employees of Fortune Financial Advisors, LLC nor their portfolios maintain positions in any of the ETFs mentioned.
The information provided above is obtained from publicly available sources and it is believed to be reliable. However, no representation or warranty is made as to its accuracy or completeness.