ETF Tracking German Stocks With a Euro Hedge Is the New Favorite

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U.S. traders are shunning a traditional exchange-traded fund tracking German shares, pouring money instead into one that protects against euro swings.

The iShares Currency Hedged MSCI Germany ETF received $135 million in May, while the non-hedged version had its first monthly withdrawals of the year. Investors opted to shield their equity returns as the dollar strengthened against the euro amid speculation about a rate hike from the Federal Reserve.

With moves in the currency becoming the main element affecting the DAX Index, hedging has become a key component of investors’ strategies. The German ETF with built-in protection climbed in May, while the other one had its worst month of 2015. And analysts are predicting the European Central Bank’s asset-buying program will help push the euro down another 5 percent at least through March of next year.

“For the DAX, you need to make a call on the currency, as well as a call on the stocks,” said Thomas Thygesen, head of cross-asset strategy at SEB AB in Copenhagen. “U.S. investors not only have to deal with euro weakness, but also dollar strength and Fed-induced volatility. It was a month where the euro was more of a risk than an opportunity.”

Investors poured $1.6 billion in the hedged German ETF this year, bringing its market value to almost $1.8 billion. Even though it’s a lot smaller than the $6.9 billion of the iShares MSCI Germany ETF, its growth has outpaced the unprotected version by eight times in 2015.

The DAX advanced 0.2 percent on Monday.

Big Theme

Currency hedging has become a big theme this year as the ECB’s quantitative easing helped drag the euro to a 12-year low in March. An ETF tracking European shares while protecting against currency swings overtook the unhedged version to become the biggest fund for the region this year. While a rebound in the currency led to its first day of outflows since October last month, the fund with built-in protection still ended up getting $520 million in May.

To Ryan Issakainen, an ETF strategist at First Trust Advisors, it’s time for investors to dump their euro hedges. The rally led by exporters at the beginning of the year has been played out, and the next leg up will be based on domestic growth, he said. An improving European economy will not only drive stocks higher, but could also push up the euro.

Unhedged Now

“Having long exposure to European equities makes a lot of sense, but my bet would be on an unhedged ETF for U.S. investors now,” Issakainen said from Wheaton, Illinois. “A year ago, that was a really good bet and that paid off well. But at this point, most of that is behind us. If you don’t take off your hedge, you’re potentially removing a contributor to returns. And paying a lot for it.”

Firms such as Stoxx Ltd. have created more currency-hedged equity products in the past year, betting that those strategies are here to stay.

“Hedging currency volatility will still be a big topic this year,” said Christian Bahr, head of product development at Stoxx. “Of course there’s a trade off, but if you’re caught by a sharp currency movement, there is no way the equity market returns will make up for your losses.”

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