Xtrackers currency hedged ETFs offer US investors a way to participate in international equity markets while mitigating the impact of foreign currency movements on investment risk and returns. By minimizing the effects of currency fluctuations, these ETFs allow for a more direct exposure to the performance of international companies. Xtrackers offers a range of currency hedged products, including ETFs for regions such as Europe, Australasia and Far East (“EAFE”), emerging markets, or Japan.
Investing in foreign equities may be an important source for both global and US investors to diversify investments. When you choose to invest in foreign equities, you’re also, whether you realize it or not, may be exposing yourself to fluctuations in the value of foreign currency. This can be compared to the experience you might have when traveling internationally. Let’s say you exchange US dollars for Euros, and then when you return, you get more or less US Dollars when you exchange back. That signifies the exposure to the fluctuations in the value of the Euro relative to the Dollar. Currency values and exchange rates can fluctuate significantly, even in the short term. The factors behind currency movements vary and are difficult to predict. Amongst these variables, central bank policy, changes in inflation rates, capital flows between countries and trade balances all play their role. Economic conditions often vary widely from one country to another, further influencing the relative strength of each currency.
These fluctuations in currency exchange rates may impact unhedged international investments that are exposed to foreign currencies. For example, let's say you invest in European stocks. If the Euro falls by 10 percent against the US dollar, your investment could lose 10 percent in dollar terms, even if the stock prices didn't change at all.
Currency hedging is a strategy used to reduce exposure to foreign exchange rate impacts while retaining the intended investment exposure to a company’s or a basket of companies’ equity. Hedging currency exposure can reduce the volatility caused by currency fluctuations and may improve the predictability of returns. Especially in times of currency instability, foreign currency hedging can potentially make a difference in providing access solely to the local returns of your international investments, allowing you to focus on the fundamental performance of your underlying investments.
Currency hedging strategies can be applied across various types of investments, from stocks to bonds, mutual funds to ETFs, and across countries and regions, ranging from EAFE (Europe, Australasia and Far East), European, Japanese to emerging markets. Currency hedging can be used by both institutional and individual investors. Instead of actively hedging currency risk through the use of currency hedging instruments such as forwards or swaps, you are able to hedge currency risks with ETFs. Understanding what a currency hedged ETF is can help you decide if this approach aligns with your investment goals.
A currency hedged portfolio aims to eliminate currency risk, leaving investors exposed solely to the performance of the local securities. This process is achieved using forward currency contracts, which lock in an exchange rate between two currencies — with Xtrackers ETFs, the US dollar and a foreign currency — for a future date. The return on these forward contracts is influenced by transaction costs and interest rate differentials, often referred to as the cost of currency hedging.
For a deeper understanding, let’s look at the Xtrackers MSCI Japan Hedged Equity ETF, which tracks the MSCI Japan Currency Hedged Index. The ETF offsets Japanese Yen currency risk by purchasing 1-month USD/JPY forward contracts. Depending on the difference in interest rates between the two currencies, these fx forward contracts trade at a premium or discount. Hence, the ETF locks in an exchange rate that may differ from the current exchange rate – also referred to as the spot rate. At settlement, any difference between the locked in exchange rate and the spot rate results in a gain or loss for the ETF.
Chart
Currency hedged ETFs can deliver notably different returns compared to unhedged investments in the same market, as illustrated within the chart by the MSCI Japan Currency Hedged vs. unhedged Index. During a time when the Japanese Yen depreciated against the US dollar, the currency hedged index (green line) yielded substantially higher returns, protecting investors from the adverse effects of an unhedged investment into the same equity market.
Going back to our example of the Xtrackers MSCI Japan Hedged Equity ETF: during this period of yen depreciation, the hedged ETF often realized gains from its USD/JPY forward contracts. These contracts, purchased at a discounted rate relative to the spot rate, yielded positive returns while avoiding investment exposure to the significant Japanese Yen weakness against the US dollar.
When evaluating if currency hedging aligns with your investment strategy, it’s essential to consider key factors such as your strategic investment objectives and your views on currency markets. Hedging foreign currency exposure can help reduce the overall volatility of international equity investments. In any case, you should weigh the pros and cons of currency hedging based on your individual circumstances and investing goals. Currency hedging could be right for you under these three circumstances:
Xtrackers offers a comprehensive range of currency hedged equity ETFs for different regions, designed to help investors manage currency risk. Whether you're looking to invest in Europe, Japan, or seeking diversified exposure to regions such as EAFE and emerging markets, these ETFs provide a simple and effective way to mitigate the impact of foreign exchange fluctuations on your returns.
Each of these funds uses currency hedging strategies to mitigate your investments from unpredictable currency movements, allowing you to focus on the performance of the underlying equities.
| Xtrackers Currency Hedged ETFs | Ticker | CUSIP | Total Expense Ratio |
|---|---|---|---|
| Xtrackers MSCI Japan Hedged Equity ETF | DBJP | 233051507 | 0.45% |
| Xtrackers MSCI EAFE Hedged Equity ETF | DBEF | 233051200 | 0.35% |
| Xtrackers MSCI Europe Hedged Equity ETF | DBEU | 233051853 | 0.45% |
| Xtrackers MSCI Eurozone Hedged Equity ETF | DBEZ | 233051697 | 0.45% |
| Xtrackers MSCI All World ex US Hedged Equity ETF | DBAW | 233051820 | 0.40% |
| Xtrackers MSCI Emerging Markets Hedged Equity ETF | DBEM | 233051101 | 0.67% |
Eventually you have to decide for yourself if currency hedging is right for you. Looking at the past ten years, the currency hedged versions have tended to deliver more stable returns by minimizing the impact of currency risk. Eventually you have to decide for yourself if currency hedging is right for you. Looking over the past ten years, the currency hedged versions have tended to deliver more stable returns by minimizing the impact of currency risk. Since 2015, investing in currency-hedged ETFs could have resulted in a significant outperformance versus their unhedged ETF counterparts for the same underlying markets.
The orange line expresses the cumulative outperformance within international equity markets, based on the MSCI EAFE 100% hedged to USD Index. This equity index is composed of large and mid-cap stocks across 21 developed markets countries, whose local performance is calculated in 13 different currencies. The index is 100% hedged to the US dollar. The green line is linked to the Japanese equity market, the blue line represents the emerging markets equity market, both based on an index 100% hedged to the US dollar.
Chart
Currency hedging is a strategy used to protect international investments from currency fluctuations. By mitigating the impact of exchange rate movements, it allows investors to focus on the performance of the underlying stocks or bonds, creating more stable returns. This can be especially helpful during periods of heightened currency instability, where exchange rates between the US dollar and foreign currencies may fluctuate meaningfully. By employing financial instruments such as forward contracts or currency swaps, currency hedging ensures that returns are less influenced by currency depreciation or appreciation.
Currency hedged ETFs are ideal for investors who want exposure to foreign markets but wish to avoid currency risk. They’re particularly useful during times of high currency volatility or when foreign currency devaluation is expected, helping to maintain steady returns. For example, when the US dollar is strengthening against foreign currencies like the euro or yen, unhedged investments may see a decline in value despite stable or positive performance in the underlying foreign assets. Currency hedged ETFs allow investors to protect against these losses while still benefiting from the growth opportunities in international markets.
While currency hedged ETFs reduce currency risk, they come with costs, including costs for hedging and a potential underperformance compared to their unhedged peers if the foreign currency appreciates. Additionally, hedging strategies rely on forward contracts, which may carry their own costs and complexities, such as transaction fees and the impact of interest rate differentials between the US dollar and the foreign currency. These costs, often referred to as the "cost of currency hedging," can reduce the net returns of the ETF. Moreover, investors should be aware that in markets where the foreign currency strengthens significantly, hedged ETFs may not capture the full upside potential that unhedged investments would experience, highlighting the importance of weighing the pros and cons of hedging based on individual goals and market conditions.
By mitigating currency fluctuations, these funds provided investors with more stable returns, particularly during periods of high currency volatility. For example, during prolonged periods of yen depreciation against the US dollar, currency hedged ETFs tracking Japanese equity markets consistently outperformed their unhedged counterparts. This difference arises because the hedged ETFs neutralize the negative impact of the weaker yen, ensuring that returns reflect the local equity performance more accurately. However, during times of foreign currency appreciation, unhedged ETFs may outperform, as they benefit from both equity returns and currency gains. These performance differences highlight the importance of aligning the choice of hedged versus unhedged ETFs with specific market conditions and individual investment strategies.
| Currency Hedging | A strategy used to protect international investments from currency fluctuations through mitigating the impact of exchange rate movements. |
|---|---|
| Drawdown | The decline in the value of an investment or portfolio from its peak to its lowest point over a specific period. |
| EAFE | The acronym EAFE stands for Europe, Australasia, and the Far East. It refers to the most developed geographical areas outside of North America. |
| Emerging Markets | Economies that are in the process of rapid growth and industrialization. These markets exhibit some characteristics of developed markets but do not fully meet their standard. |
| FX Forward Contract | A contractual agreement between two parties to exchange a specified amount of one currency for another at a predetermined exchange rate on a future date. |
| MSCI EAFE | A stock market index designed to measure the equity market performance of developed markets in the EAFE regions. |
| Settlement | The process of completing a trade or transaction, where the buyer receives the purchased securities, and the seller receives payment. |
| Spot Rate | The current price at which a particular asset, such as a currency, commodity, or security, can be bought or sold for immediate delivery. |
| Swap | A derivative contract through which two parties exchange the cash flows or liabilities from two different financial instruments. |
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