BlackRock Vies With State Street to Tap Currency-Hedged ETF Boom

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The world’s biggest money managers are staking a claim in the surging market for stock and bond ETFs that strip out currency risk.

Industry giants BlackRock Inc. and State Street Corp. are rolling out hedged exchange-traded funds at an unprecedented clip after smaller rivals lured the bulk of $41 billion of inflows this year. BlackRock started 11 of the funds this month, including ETFs protecting against moves in the Australian dollar and Mexican peso, while State Street opened a euro-focused version in June.

Sitting out the year’s most popular strategy isn’t an option for fund companies, which are increasingly reliant on exchange-traded products to generate income. The number of currency-hedged ETFs listed in the U.S. has doubled during the past year to 60, with at least 30 more registered with regulators, according to data compiled by Bloomberg.

“It’s been fast and furious with issuance,” said Kevin Kelly, the New York-based chief investment officer at Recon Capital Partners, which manages more than $300 million and has bought funds focused on Germany. “Some of the newer products are going to have a tough time, especially if they’re levered, especially if they just cover a broad index that is already out there from another issuer.”

Growth Leader

The companies are tapping into growing demand from U.S. retail investors who’ve sought exposure to international stocks and bonds but want to avoid exchange-rate fluctuations.

WisdomTree Investments Inc.’s Europe Hedged Equity Fund has added $14.5 billion this year, more than any other ETF in the world, while returning 17 percent. Deutsche Asset & Wealth Management’s hedged ETF focusing on developed economies in Europe and Asia has pulled in $10.9 billion. The products have gained traction as monetary policy in the U.S. diverges from the rest of the world, boosting the greenback to multiyear highs and imperiling international returns for American clients when translated back to dollars.

Clients “are looking for more options to help them manage their currency risks, which is why we added more single countries, regions and small cap,” Jane Leung, the San Francisco-based head of precision exposures at iShares, BlackRock’s ETF unit, said via e-mail.

Cutting Fees

Together, ETFs and passively managed funds will take in about 35 percent of flows into investment products from 2015 to 2018, up from 14 percent last year, according to a Boston Consulting Group Inc. report released last week.

That’s prompting a race to the bottom on fees as entrants look to attract investors from more established peers. State Street, Invesco Ltd.’s PowerShares and ProShare Advisors LLC all recently started their first hedged funds charging about half the market average, which is about 0.5 percent, Bloomberg data show.

“We have to compete,” Steve Cohen, head of strategy at ProShare Advisors in Bethesda, Maryland, said by phone July 8. “Maybe in this particular case it’s going to put less into the bottom line but we’re OK on that.”

Party Ending

Other providers are getting creative with their focus or structure. In June, Direxion Investments started the first leveraged currency-protected ETFs to amplify returns. Funds sometimes use swaps or derivatives to accomplish that.

“Since we’re employing leverage to these benchmarks that’s definitely a differentiator,” Edward Egilinsky, the New York-based head of alternative investments at Direxion, which offers European and Japan funds, said by phone July 7.

Trouble is, all these products may be a little late to the party. Flows are slowing, with investors channeling $2.77 billion into them last month, the least since December.

“We’re less concerned about the short term,” said Nick Good, Boston-based chief operating officer of the U.S. intermediary business at State Street. “There obviously has been a burst of demand and that won’t continue indefinitely, but we do see long-term demand for hedged as well as unhedged versions of key ETFs.”

While the dollar is forecast to gain versus 13 of its 16 major peers by year-end, its advance is decelerating. The greenback is predicted to strengthen about 5 percent versus the euro by Dec. 31, after rallying about 24 percent over the last 12 months.

Unhedged Resurgence

That has some existing and wannabe providers of hedged ETFs taking a different tack: pitching investors looking to cautiously return to unhedged investments.

New York Life Insurance Co. is planning five 50 percent-hedged funds through its IndexIQ unit, while BlackRock is marketing a strategy that rotates between hedged and unhedged products.

“You can actually easily flow back and forth,” Leung at iShares said in a June 30 interview. “Volatilities and correlations change rapidly. You do have to be aware if you’re using this as a tactical play to be monitoring those movements and adjusting your ratio accordingly.”

For more, read this QuickTake: Exchange-Traded-Funds

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