WisdomTree launches currency-hedged ETF providing exposure to non-US dividend-paying firms

Jun 30th, 2015 | By | Category: Equities

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WisdomTree, a leading global provider of exchange-traded funds, earlier this month launched the Global ex-US Hedged Dividend ETF (DXUS) on the NYSE Arca. The fund tracks the WisdomTree Global ex-US Hedged Dividend Index, an index providing exposure to a selection of dividend-paying firms listed outside the US whilst also mitigating against adverse movements in international currencies by way of an in-built currency hedge.

WisdomTree have announced the launch of a new currency-hedged ETF, providing exposure to non-US dividend-paying firms

WisdomTree have launched a new currency-hedged ETF, offering exposure to non-US dividend-paying firms

The fund provides investors with several key benefits including the opportunity to invest in international companies and the potential to capture enhanced returns and diversify exposure; the provision of a regular income stream; and the ability to pursue these investments while avoiding currency risk.

For a firm to be considered for inclusion in the index, it must meet a series of criteria. Firstly, WisdomTree performs liquidity screening protocols when selecting the constituents of the index, reducing the risk of dealing with thinly-traded stock which may have an adverse effect on execution price if trade orders are relatively large. These rules factor out stocks that have had less than 250,000 shares traded per month over the previous six months. Further liquidity controls include prohibiting the inclusion of stocks trading in developed markets that have had less than $100,000 worth of trading volume on average per day over the last three months and excluding stocks trading in developing markets that recorded less than $200,000 of average daily trading volume over the last six months. Secondly, firms must have distributed a minimum of $5m in dividends to investors over the last year.

The index then weights securities according to their relative dividend streams, adding more exposure to firms paying higher total dividends.

For various reasons, including tax treatment, US-based firms have historically paid out less in dividends than international firms. Last year, 79% of listed US firms paid dividends and only 9% of those had dividend-yields of greater than 3.8%. By basing the index on firms outside of the US there is greater exposure to dividend streams and the impact that dividend payments have on performance. Over a third of the stocks in the index currently have dividend yields of over 3.8%, while another third have dividend yields between 2.4% and 3.8%.

The fund is well diversified and currently holds 391 different securities. It is mostly invested in large-cap stocks (87.9%), defined as those with a market-cap larger than $10bn. Mid-cap stocks, those with market capitalization between $2bn and $10bn, account for 12%. The largest holdings are currently Toyota (1.9%), Novartis (1.5%), Nestle (1.4%), Roche (1.3%) and Vodafone (1.2%). Sector exposures are capped at 25% on re-balancing dates but may fluctuate above this cap between dates due to the relevant movements in the price of underlying stocks. As such, the current sector exposures are financials (25.1%), consumer discretionary (11.1%), telecommunications (9.9%), consumer staples (9.8%) and industrials (9.6%).

The fund is currently concentrated in securities based in Japan (19.1%), the United Kingdom (15.6%), France (8.1%), Switzerland (8%), and Canada (6.9%). As such the fund would have a large exposure to the yen, pound, euro, Swiss franc and Canadian dollar. However it has historically been the less prominent currencies that experience the largest volatility and could cause significant losses to the international investor despite the smaller allocation within the fund. The in-built currency hedge utilizes 27 currency forward contracts to mitigate this risk across all currencies.

The MSCI ACWI ex-US Index, a close substitute for an unhedged version of the recently created WisdomTree index, consistently experienced currency drag over the previous ten years. This currency drag ranged from -0.8% to -6.4% per year, being more pronounced lately due to the strong appreciation of the dollar in recent years. When comparing the MSCI ACWI ex-US Index from a currency hedged or unhedged position, there were consistently lower Sharpe ratios with the unhedged version. WisdomTree thus argues that leaving the fund exposed to currency risk may increase volatility with no corresponding increase in expected return. It would seem logical for the investor to enact a currency hedge and only accept currency exposure when the investor holds a specific view as to future currency movements.

WisdomTree proposed that enacting currency-hedging over the previous 10 years resulted in superior portfolio allocations with better risk-return combinations. (Graphic © WisdomTree)

The graph above illustrates the case made by WisdomTree as to the benefit of including currency-hedging into a portfolio over the last ten years. Each of the lines, known as ‘Markowitz Bullets’, correspond to a set of portfolios that invest in various proportions in the MSCI ACWI ex-US Index and the S&P 500. The bottom most point of each line represents a 100% investment in the MSCI ACWI ex-US Index while each of the points moving upwards along the curve represents a 10% incremental decrease in the proportional weight of that index and a 10% incremental increase in the weighting of the S&P 500.

The brown line represents the set of portfolios with no currency hedging, the green line represents partial currency hedging and the blue line shows the set of portfolios with a full currency hedge.By showing that the curve bows out to the left when adopting currency hedging, WisdowTree point to the fact that mitigating currency risk on the MSCI ACWI ex-US Index over the last ten years has led to superior portfolio risk-return combinations.

The expense ratio of the fund is 0.44%.

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