Exchange-traded funds designed to minimize the impact of currency fluctuations on non-U.S. stocks have seen sharp outflows in 2017, as a weaker U.S. dollar turned their hedging strategies into a headwind.
The Xtrackers MSCI EAFE Hedged Equity ETF /zigman2/quotes/201636616/composite DBEF +0.07% has seen outflows of more than $1.6 billion this year, the third-highest of any ETF on the market. That was closely followed by the WisdomTree Europe Hedged Equity Fund /zigman2/quotes/207911216/composite HEDJ -0.15% , from which more than $1.2 billion has been redeemed.
The ICE U.S. Dollar Index /zigman2/quotes/210598269/delayed DXY +0.47% , which measures the buck against a basket of major rivals, is down 8.4% thus far this year. Earlier this year, it fell to its lowest level since 2014.
The dollar’s weakness is largely a reflection of the euro’s strength. The shared currency /zigman2/quotes/210561242/realtime/sampled EURUSD -0.4912% has gained 12% versus the dollar this year as traders viewed the eurozone economy to have more room to grow compared with that of the U.S.
“A low dollar is a headwind if you’re hedging, and these are tactical products for investors who want to make two bets: that the underlying equities will rise, while their local currency falls,” said Maxwell Gold, director of investment strategy at ETF Securities. “If you’re in these types of products at a time when the dollar weakens, that’s a negative to your total return.”
Hedging means these funds have underperformed the funds that offer similar equity exposure, without currency adjustments. While WisdomTree’s hedged European fund is up 13.4% in the year tod ate, the Vanguard FTSE Europe ETF /zigman2/quotes/200270338/composite VGK -0.70% , which offers broad equity exposure to Europe, is up nearly 22%. The difference is largely attributable to the rise in the euro against the dollar.
While the euro has been the bigger mover among major rivals to the dollar, this trend has also been seen ETFs tied to the Japanese yen. The dollar is down 2.9% against the yen in 2017.
The Xtrackers MSCI Japan Hedged Equity ETF /zigman2/quotes/203982701/composite DBJP +0.72% has seen outflows of $587 million, while $494 million has been pulled from the similarly themed WisdomTree Japan Hedged Equity Fund /zigman2/quotes/203865992/composite DXJ +0.59% . The Xtrackers fund is up 13.4% in 2017. The iShares Currency Hedged MSCI Japan ETF /zigman2/quotes/208320118/composite HEWJ +0.51% is up 15.5%, compared with the 17.7% rise of the non-hedged iShares MSCI Japan ETF /zigman2/quotes/201162210/composite EWJ +0.35% .
According to data from ETFGI, an ETF research firm, there is $133.8 billion held in currency-hedged products globally. At the end of September, there were 771 such products on the market, listed in 20 countries.
Currency-hedged products work by overlaying a forward currencies contract over the equity holdings of a portfolio.