Hedging strategies (or a lack thereof) are often a hot topic for Europe-focused funds, and can play a major role in fund returns. In 2016, when the dollar was ascendant, the iShares Currency Hedged MSCI Germany ETF (HEWG) delivered a 9 percent return, well ahead of the 3.6 percent return of the iShares MSCI Germany ETF.
Of course, with the dollar losing ground this year, the unhedged fund’s roughly 18 percent year-to-date return is far better than the currency-hedged fund’s 6 percent return.
Marc Chandler, global head of currency strategy at Brown Brothers Harriman, thinks it’s time to focus again on currency-hedged funds. “Many investors think the dollar rally of recent years has come to an end. I think it’s just a correction in an otherwise upward trend for the dollar,” he says.
Chandler notes that the Federal Reserve is expected to raise interest rates at least twice in the next 12 months, while the European Central Bank (ECB) is expected to stand pat. Also, Chandler predicts the Fed will shrink its balance sheet by $180 billion over the next three quarters while the ECB continues to expand its balance sheet.
Chandler says this “divergence theme” should help the dollar to rally anew, which would blunt some of the gains of unhedged ETFs. On the flip side, a weaker euro, relative to the dollar, would help German exports to remain competitive.
That theme would favor the WisdomTree Germany Hedged Equity Fund (DXGE). The fund, which has a 0.48 percent expense ratio, focuses on export-oriented German firms that produce steady dividends. The fund's top holdings include BMW, BASF, Siemens and Daimler.
The German economy is now benefiting from a range of tailwinds: The ECB is poised to remain in stimulus mode for a while longer, even as the U.S. Fed begins to tighten monetary policy; Germany’s key trading partners in Europe are showing renewed vigor; and German stock market valuations remain more attractive than the U.S. Those factors should help German ETFs to deliver further gains on both a hedged and unhedged basis.