WisdomTree introduces dynamic currency-hedged ETFs

Jan 7th, 2016 | By | Category: Equities

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WisdomTree, a leading provider of exchange-traded funds, has expanded their line-up of currency-hedged solutions with the launch of four dynamically hedged ETFs targeting broad European, Japanese, international, and international small-cap equity exposures. The funds began trading on the BATS Exchange on 7 January 2016.

WisdomTree embraces dynamic currency-hedging with suite of new equity ETFs

WisdomTree’s new funds employ a rules-based evaluation of drivers of exchange-rates to determine the extent of currency-hedging required.

Research from WisdomTree indicates that exposure to foreign currencies has historically increased portfolio volatility both in the short- and long-term without significantly increasing expected returns. According to these findings, by not hedging currency risk investors are accepting greater volatility without receiving compensation in the form of the potential for greater returns. Despite a growing awareness of this negative effect, investors appear reluctant to adopt fully hedged strategies that would fail to capture additional profits from favourable movements in foreign exchange markets.

WisdomTree believes this conflict may be addressed through ETFs which apply flexible currency-hedging. A rules-based analysis of key fundamental drivers of exchange rates is applied to determine the necessity and extent of hedging required given current market conditions. WisdomTree argues that this ‘dynamic currency-hedging’ process has the potential to enhance portfolio risk-adjusted returns.

Jeremy Schwartz, WisdomTree Director of Research, commented: “WisdomTree’s dynamic currency-hedged strategy limits the need to make a call on currency by utilizing a data-driven, rules-based approach that assesses the picture of developed market currencies relative to the US dollar on a monthly basis. This offers the potential for an attractive strategic and baseline exposure for long-term portfolios.”

The extent of currency hedging is determined by examining three signals drawing upon technical analysis and fundamental economic theory. They are: momentum, interest rate differential and value.

  • Momentum: A downward trend in the currency relative to the US dollar would signal to put on a hedge, whereas an upward or appreciating trend would signal to take it off.
  • Interest Rate Differential: If the implied interest rate in the United States is higher than that within the country or region of the targeted currency, it is more attractive to hedge and earn the difference, known as “carry.” Conversely, if the implied interest rate within the country or region of the targeted currency is higher than that of the United States, it is less attractive to hedge as it results in a carry expense. This signal helps manage the cost of hedging as the cost attributable to interest rates becomes greater.
  • Value: If a currency is over-valued relative to the US dollar based on a widely known measure of purchasing power parity, it is more attractive to hedge and when undervalued, it is less attractive to hedge. This is a long run signal and there is a wide band before this signal is applied to the fullest extent.

Therefore, for example, stronger downward momentum of a foreign currency against the US dollar, an increase in the implied interest rate in the US compared to the foreign country in question, and increases in the foreign currency’s value relative to the US dollar based on purchasing power parity, would all suggest a greater level of currency hedging is required. Conversely, a decline or reversal in any of these signals would trigger a reduction in percentage of hedging required.

The signals are equally-weighted at one-third each in terms of contribution to the overall portfolio hedge ratio. The hedge ratio is reset on a monthly basis

The four new funds are:

WisdomTree Dynamic Currency Hedged Europe Equity Fund (DDEZ)
WisdomTree Dynamic Currency Hedged Japan Equity Fund (DDJP)
WisdomTree Dynamic Currency Hedged International Equity Fund (DDWM)
WisdomTree Dynamic Currency Hedged International SmallCap Equity Fund (DDLS)

DDEZ, DDJP and DDLS each have net expense ratios of 0.43%; DDWM carries a net expense ratio of 0.35%.

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