U.S. fund investors are in no rush to shore up defences against the strong dollar. The greenback‘s 6% leap over the past six months has flummoxed markets from Turkey to Argentina, whose governments have to repay debt in dollars.
The stronger currency, which makes U.S. exports more expensive to foreign buyers, has also frustrated President Donald Trump, who is trying to reduce U.S. trade deficits.
Yet among the least popular exchange-traded funds (ETFs) this year are “currency hedged” funds, which invest in stocks abroad but strip out the effect of a foreign currency’s performance using derivatives. That makes the funds more resilient in a “King Dollar” world, when the greenback is dominant, which hurts U.S. investors converting foreign stock gains back into dollars.
‘Gone too far’
Some investors are betting that the dollar’s run has gone too far given the risk of seismic U.S. Congressional elections in November or the potential for the U.S. Federal Reserve to slow down the pace of interest rate hikes.
“We’re not really hedged right now even though the consensus is for a strong dollar,” said Komson Silapachai, vice-president of research and portfolio strategy at Sage Advisory Services Ltd. “We think there’s a bigger chance that the market is underpricing the chance for a weaker dollar.”
U.S.-based currency-hedged funds have logged $10.2 billion in withdrawals this year, while their unhedged counterparts have attracted $30.7 billion, according to FactSet Research Systems Inc. That is a break from past practice when investors rewarded currency-hedged funds as the dollar gained.
Hedged funds took in $51.9 billion in 2014 and 2015 as the dollar leapt by more than a fifth, FactSet data shows. Currency-hedged ETFs nearly tripled in number from 20 to 58 from 2014 to 2016 in the United States. The figure has not grown since 2017.
In the more than eight months of the year-so-far, the dollar has depreciated about 2% against the yen but gained more than 3% against both the euro and a basket of top trading partners’ currencies.
The euro’s decline helped the WisdomTree Europe Hedged Equity Fund, up 5.2% this year, significantly outperform the nearly flat 0.4% return of the unhedged Vanguard FTSE Europe ETF, according to Thomson Reuters’ Lipper research unit.
Nonetheless, the hedged WisdomTree Europe fund hemorrhaged $2.2 billion because of withdrawals this year, far higher than the $755 million investors pulled from the unhedged Vanguard Group Inc. product, Lipper said.
Still, the dollar tends to falter later in the year, especially ahead of U.S. midterm elections, Silapachai said. The November elections could hand control of the U.S. Senate or House of Representatives to Democrats, who are currently in the minority, opinion polls show. The dollar could also falter if rates do not keep rising.
Rising rates attract yield-hunting foreign investors, but the Fed could delay hikes if inflation stays tame or the economy deteriorates. Short-term rates controlled by the Fed are getting closer to topping long-term rates set by the market, an omen for recession.
