On a recent flight, Susanne Alexandor saw an advertisement for currency-hedged exchange-traded funds. The promotion on the seat in front of her highlighted just how aggressively these strategies are being marketed to the masses.
“They are incredibly appealing for the retail space because the retail investor can separate out the market decision from the currency decision,” said Alexandor, a Toronto-based senior member of the investment team at Cougar Global Investments Ltd., which has about $1.5 billion in assets under management and advisory for clients including high net-worth individuals.
The money backs up the attraction: Currency-hedged ETFs in the U.S. have taken in a record $39.6 billion this year, up from $8.9 billion for all of 2014, data compiled by Bloomberg show. Flows into the funds have more than quadrupled as exchange rates swing in the face of central-bank surprises from Europe to Canada and New Zealand.
The strategies may prove to be even more valuable as a growing gap between monetary policy in the U.S. and elsewhere puts individual investors in a bind. The Federal Reserve is preparing to raise interest rates for the first time since 2006, which threatens to hurt gains in stock markets from the euro area to Japan -- where central banks are easing -- with a strengthening greenback. Hedged funds, forged during precipitous declines by the euro and yen, remove this risk.
“Having seen the difference between currency hedged and unhedged returns from the same country, investors realize now we live in abnormal times,” said Linda Zhang, senior portfolio manager and head of research in Boston at Windhaven Investment Management Inc., which has more than $15 billion under management, including for individuals. “The awareness and education has certainly been heightened.”
The euro and the yen have plunged about 17 percent in the past year. Europe’s shared currency is forecast to slump another 6.6 percent by year-end, while the yen will decline 1.3 percent. Mexico’s peso is the only one of 16 major currencies predicted to rally versus the dollar by Dec. 31.
A Europe-hedged fund run by BlackRock Inc.’s iShares has returned 13 percent this year, exceeding the 6.8 percent gained by its unhedged equivalent.
While institutions can also purchase the funds, they may choose to hedge in-house, thereby avoiding the higher expense ratio associated with buying a protected product, Matthew Whitbread, a Boston-based investment manager at Baring Asset Management, said by phone June 11. That’s not an option for individuals.
Hard data on ownership is scant, but low trading volumes suggest currency-hedged products are primarily owned by retail investors, according to Eric Balchunas, a Bloomberg Intelligence analyst in Skillman, New Jersey. Average daily trading for the two most popular funds this year is less than 2 percent of their assets under management as of June 12.
“A lot of these clients that we’re working with are looking at these funds if they want exposure to the currency space,” said Erika Doede, the San Francisco-based head of adviser sales and trading at Susquehanna Financial Group. “Everybody realized that with the strength of the dollar a lot of these products would be getting off the ground, and getting off the ground more quickly.”
Those inquiries have prompted a swathe of new and existing issuers to boost the number of currency-hedged products they offer.
State Street Corp. entered the currency-hedged market in the U.S. this month with a Europe-focused product and further offerings may follow. Invesco Ltd.’s InvescoPowershares came out with a similar product in May, while WisdomTree Investments Inc. has added two hedged international funds to its stable in recent weeks. BlackRock’s iShares unit is seeking approval to market 11 new hedged funds in the U.S.
Even international investors are taking notice. David Krejca, a 24-year-old part-time financial researcher in Prague said he recently invested $10,000 across three hedged U.S. ETFs. Canadian Larry MacDonald, a freelance writer in his fifties, said he has about C$15,000 ($12,160) in two currency-hedged ETFs.
“I knew that if I bought a regular Japan fund, I could lose a lot of the gain from the stock market from the yen depreciating, so I wanted to get a currency-hedged product to minimize that,” MacDonald said by phone from Ottawa. “It’s done very well for me.”
For more, read this QuickTake: Exchange-Traded Funds