Frenzy for Currency-Proof ETFs Fizzles as Dollar Rally Expires

  • Investment flows into products shrinks to least in 11 months
  • Hedged funds trail naked versions on foreign-exchange shifts

Some of this year’s hottest exchange-traded funds are starting to look like a flash in the pan.

When the dollar’s 21 percent, nine-month rally through mid-March was hurting returns for investors in stocks outside the U.S., ETFs that hedge against declines in other currencies made sense. Now, with an index of the dollar little changed in September, investors have directed the least money into such products in almost a year.

While these funds outperform their naked, or unhedged, counterparts when the U.S. currency strengthens, buyers have felt the pinch as the greenback’s rally leveled off and stocks fell. Direxion Investments’ leveraged Japan fund paced declines with a 26 percent slump. James Doyle, a spokesman for New York-based Direxion at JCPR Inc., didn’t have an immediate comment when reached by phone Monday.

“Hedging of the U.S. dollar actually hurt you more than you would have been hurt if you didn’t hedge,” said Gary Stringer, chief investment officer at Stringer Asset Management LLC in Memphis, Tennessee. “Maybe this particular niche won’t be as popular as it was earlier in the year.” 

The company, which manages about $300 million, began lowering its currency hedges during the March-June period and now has none, he said.

Currency-hedged products attracted $794 million of inflows this month, the least since last October, data compiled by Bloomberg show. That’s down from as much as $11.5 billion in March and only 4 percent of money gained by U.S. ETFs in September.

That poses a problem for fund sellers. The likes of BlackRock Inc. and State Street Corp. have created 42 hedged funds since Dec. 31 in an attempt to capture some of the $47.3 billion that’s flowed into these products. 

Fund Flows

The latest funds have garnered less than 2 percent of inflows. And with performance deteriorating, ETF companies are left competing for a shrinking supply of fresh money.

All of the 41 equity ETFs that have a currency hedge and were created more than three months ago lost money this quarter. Japanese funds have spearheaded losses, as the yen appreciated 2.3 percent versus the dollar.

The outcome was a surprise as the average forecast of analysts surveyed by Bloomberg at the end of last year was for Japan’s currency to weaken to 124 per dollar by the end of September. Instead, it was at 119.72 as of 3:52 p.m. in New York.

BlackRock’s iShares Currency Hedged MSCI Japan ETF, for example, lost 16 percent in the past three months, exceeding the 13 percent loss of its unhedged counterpart.

More Choice

The products are designed so investors can move between hedged and unhedged funds, said Daniel Gamba, head of BlackRock’s iShares Americas institutional business.

With the Federal Reserve thus far refraining from raising interest rates, forecasters have been scaling back predictions for U.S. currency strength, and investors are reallocating capital.

Money has been moved from currency-hedged funds to similar products that preserve the foreign-exchange risk, said James Gardiner, a managing director at JA Forlines LLC, which manages about $425 million from Locust Valley, New York.

“We’ve been paring back our currency hedges and going basically currency neutral for the last quarter and a half,” he said. “With the most recent Fed decision and some of the economic data coming out, we’re pretty happy that we are 50/50 here because we’re not as confident that the dollar is going to resume its strength.”

Long Term

Net inflows this year remain the most on record, with funds focused on Japan and Europe exceeding the returns of their unhedged counterparts during the past nine months.

Appetite for these products depends on an investor’s time-frame, according to Susanne Alexandor, a Toronto-based senior member of the investment team at Cougar Global Investments Ltd., which has about 5 percent of the roughly $1.5 billion it manages in BlackRock’s hedged Japan fund. While the yen has gained since the end of July, it has slumped about 35 percent against the dollar during the past three years.

“The divergent monetary policy that started happening several years ago is continuing, but maybe at a slower pace,” Alexandor said. “It all depends on your time horizon.”

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