ETFs Forced to Get ‘Smart’ Hedging Dollar With Easy Money Gone

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Chart: Dollar strength this year

The most popular strategy in the $2.1 trillion U.S. market for exchange-traded funds is losing its luster, leading the world’s biggest asset managers to search for ways to keep the money flowing.

ETFs that hedge against currency risk have attracted just $5.9 billion since the end of June as a rally in the greenback slowed. That compares with the $41 billion they lured in the first six months of the year, when a surging dollar imperiled international returns for U.S. investors.

With the record inflows fading into memory, fund managers including a Deutsche Bank AG unit and BlackRock Inc. are turning to new strategies to attract more sophisticated investors. Currency-hedged products that focus on niches such as low-volatility and high-dividend stocks are gaining traction. The two most popular currency-hedged ETFs started this year both use that approach, dubbed “smart beta” in industry parlance.

“The currency hedging story is all about managing risk, as are certain smart-beta strategies,” said Joseph Nelesen, head of institutional-product strategy and consulting for BlackRock’s iShares business in the U.S. “It feels like a natural way to extend the range.”

The dollar’s 6.6 percent advance versus its 10 major peers in 2015 has crimped investors’ overseas gains when translated back into the U.S. currency.

Smart Beta

That’s prompted a flurry of new funds that protect against currency risk, more than doubling the number of hedged ETFs to 74 in the last 12 months. With U.S. investors in overseas stocks now awash in choices, fund providers are turning to smart-beta strategies to differentiate themselves.

Smart-beta funds account for more than $400 billion in domestic ETFs, up about 10-fold in the last decade, according to Bloomberg Intelligence. Some 36 percent of managers who use ETFs deployed smart-beta products as of the end of 2014, up from 24 percent a year earlier, according to a survey published this year from Invesco Ltd. and Market Strategies International.

“Currency hedging and smart beta are two of the biggest trends right now,” David Perlman, an ETF strategist at UBS Wealth Management, said in an interview at Bloomberg’s New York headquarters. “We’re going to see providers differentiate on how they’re selecting securities and how they’re weighting them.”

‘Shark Tank’

Of the 38 currency-hedged funds started this year, New York-based WisdomTree Investments Inc.’s Europe Hedged SmallCap Equity Fund and Invesco’s PowerShares Europe Currency Hedged Low Volatility Portfolio have taken in the most money, attracting $223 million and $155 million, respectively. Both use the smart beta approach.

Deutsche Asset & Wealth Management, an arm of the Frankfurt-based bank, rolled out four dividend-chasing currency-hedged ETFs on Aug. 12.

The industry may not be done introducing products. The dollar is forecast to strengthen against its Group of 10 peers by year-end, adding more than 5 percent versus the Danish krone and the euro, according to data compiled by Bloomberg.

New York-based BlackRock plans to market four minimum volatility products with currency hedges. O’Shares Investments, an ETF provider set up by Kevin O’Leary, star of ABC’s “Shark Tank,” plans to debut two hedged products focusing on low volatility and dividend-paying stocks in Europe and the Asia-Pacific region this month.

“We wanted to make sure there was substantial value-added, and that we’d be able to win mandates from the biggest investors in the world,” Connor O’Brien, chief executive officer at O’Shares, said by phone from Montreal. It’s “a next-generation strategy.”

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