Euro Traders Ditch Hedges as Growth Rebound Exposes Naked Gains

Money is pouring into Europe, and less and less of it is hedged as traders speculate on an end to the euro’s one-way down trade.

Investors directed the least money into strategies that protect against currency fluctuations since December last week on speculation the 19-nation currency hit bottom versus the dollar after plummeting to a 12-year low in March. Better economic data out of Europe has combined with signs of slowing U.S. growth to push the euro to a two-month high.

“We’ve been a lot more bullish on Europe versus the U.S. for a few months now,” Matthew Whitbread, a Boston-based investment manager at Baring Asset Management, said by phone April 30. “We’ve made changes in our portfolios to reflect that and we’ve actually moved most of our exposure out of the U.S. and put most of it into Europe.”

The economy’s rebound from three years of sub-1 percent growth and flirtation with deflation shows European Central Bank President Mario Draghi’s unprecedented bond-buying plan to support growth is gaining traction. Investors have jumped back into the region’s assets, boosting stock markets to record highs. And while the euro is still forecast to end the year 8 percent weaker, traders have trimmed bets against the currency to a six-week low.

That’s got investors like Barings wondering whether all those hedges are really needed.

Euro Flows

A total of $531 million was directed into 40 U.S. exchange-traded funds that hedge against currency moves last week, the least since the period through Dec. 19 and down from a high of $3.47 billion in early March, data compiled by Bloomberg show. Flows into WisdomTree Investments Inc.’s Europe Hedged Equity Fund -- the most popular U.S. ETF this year -- slumped to $72.8 million, the least since October.

The funds use forward contracts to buy or sell the currency in which their assets are denominated, thereby mitigating its impact on international investors’ returns.

Hedging became attractive as an almost yearlong plunge sent the euro down as much as 25 percent from a 2 1/2-year high reached last May, eating into profits.

The slowdown in the practice came as economic reports from the euro area exceeded expectations since the end of January, while those from the U.S. have missed, Citigroup Inc. measures show. The reversal coincides with the start of the ECB’s 1.1 trillion euro ($1.3 trillion) quantitative-easing program, announced Jan. 22.

‘Tactical Move’

All that’s helped stabilize the euro and attract investment that pushed the STOXX Europe 600 Index to the highest level since 1987, further supporting the currency.

The euro rallied 4.6 percent in April, its first monthly gain since June and its biggest in 4 1/2 years. It was at $1.1282 at 12:15 p.m. in New York, after sliding to $1.0458 on March 16, the least since 2003.

Barings has pared its bets against the euro in a “short-term tactical move,” Whitbread said. The money manager favors European telecommunications companies and real-estate investment trusts.

“We’re seeing right now a lot of interest going back to some of the unhedged products,” Joseph Nelesen, head of institutional-product strategy and consulting for BlackRock Inc.’s iShares business in the U.S., said May 1. “The euro and the yen for the moment seem to be stabilizing a bit, so we’re seeing a lot of tactical use.” The company offers five currency-hedged ETFs.

Euro Forecasts

The unhedged strategies may yet backfire, if Wall Street’s forecasts are accurate. The consensus is for the shared currency to weaken to $1.05 by year-end, according to the median forecast of more than 60 analysts surveyed by Bloomberg News. Morgan Stanley is even more pessimistic, seeing the euro at 98 U.S. cents by Dec. 31, while another 11 banks predict the currency will reach parity with the greenback during the same period.

Still, some investors see the days of the one-way trade against the euro as over.

Many clients are now using hedged and unhedged strategies to complement one another, according to Christopher Gannatti, the New York-based associate director of research at WisdomTree.

A hedged iShares ETF that gained 14 percent this year has lost 4.6 percent in the past month; its unhedged equivalent has fell 0.8 percent in the last month.

“If you don’t want to be stuck on one side or the other, it could make sense to have as your baseline strategy the 50:50 hedged/unhedged type of approach,” Gannatti said by phone April 27. “It’s now becoming much more about the strategy itself, how it’s constructed and how the underlying companies are doing.”

-With assistance from Eric Balchunas in Skillman, New Jersey.

Before it's here, it's on the Bloomberg Terminal.
LEARN MORE