Profit From Currency Hedged ETFs If The Euro Falls To Parity

The long-awaited milestone – euro parity with the U.S. dollar – seems much real now given the political uncertainty in Europe and the fiscal splurge in the U.S. The slump in euro and the surge in greenback could lead to $1 worth €1, a situation last seen in 2002.

Euro-Dollar Parity in the Cards?

Notably, the dollar surged to the highest level in almost 14 years to 0.96 against the euro while euro tumbled to 1.0353 against the greenback.

The trend is likely to continue given that the U.S. economy has gathered momentum with increasing inflation and the longest streak of overall job growth since the financial crisis.
President-elect Trump is acting as a trump card for the currency as he promised to accelerate economic growth, spend big time on infrastructure, reduce regulations and slash taxes to create an inflationary environment.

This has raised the prospect of further interest rate hikes next year with the Fed now eyeing three lift-offs compared to two previously. In particular, a rise in interest rates will pull in more capital into the U.S. and lead to further appreciation of the greenback. On the other hand, a terrorist attack in Germany and loose monetary policies by the European Central Bank (ECB) are resulting in lower euro. The political drama resulting from the wave of high-stake elections in several Eurozone countries next year will further weigh on the euro (read: Fed Hike Looks Likely, Time for High Dividend Europe ETFs?).  

Given the current trends, the euro will soon reach parity with dollar. According to the head economist of Oxford Economics Adam Slater, the parity could be reached by the end of the next year while many other economists think the key milestone will be hit even sooner. Analysts at Goldman project the parity of the two currencies by the fourth quarter of 2017.

Solid European Fundamentals

On the other side, weak euro is making the European products cheaper for Americans. As such, a slumping euro is actually benefiting exporters and the manufacturing industry, resulting in soaring stock prices. Further, the European economy is on a solid footing as growth in the Eurozone has picked up momentum with an increase in inflation.

Earlier this month, the ECB extended its bond-buying program by nine months until the end of 2017 but reduced the amount to €60 billion from €80 billion starting in April 2017. The bank kept its interest rates at record lows for an extended period to support the economy and boost inflation. This underscores the growing confidence in the European economy (see: all European ETFs here).

In the latest development, Italy has stepped up its efforts to stabilize the struggling banking sector as it is preparing for a potential €20 billion rescue package for the country's ailing banking system. The move has infused optimism into the European outlook pushing the stocks higher.

How to Play?

While encouraging economic fundamentals is making European investment a compelling opportunity in the U.S., a strong dollar could wipe out gains when repatriated in U.S. dollar terms, pushing the investment into red even when European stocks performed well. As a result, investors flocked to currency hedged ETFs to tap bullish fundamentals, dodging the effects of a strong greenback.

All of these funds offer exposure to the broad European stocks while at the same time provides hedge against any fall in the euro.

WisdomTree Europe Hedged Equity Fund (HEDJ - Free Report)

This fund tracks the WisdomTree Europe Hedged Equity Index. In total, the fund holds a well-diversified portfolio of 134 stocks with each holding less than 5.4% share. However, it is pretty well spread across a number of sectors with industrials, consumer discretionary, consumer staples, and financials taking double-digit exposure each. Among countries, Germany (26.2%), France (24.8%), Spain (18.4%) and the Netherlands (16.1%) dominate the holdings list. HEDJ is one of the popular and liquid choices in the European space with AUM of about $8.9 billion and average daily volume of about 2.5 million shares. Expense ratio came in at 0.58%. The fund has gained 9.8% so far this year (read: 5 Currency Hedged ETFs Made Great Again by Trump).

Deutsche X-trackers MSCI Europe Hedged Equity ETF (DBEU - Free Report)
This product tracks the MSCI Europe US Dollar Hedged Index, holding 449 securities in its basket. It is widely spread out across each component with none holding more than 2.92% of assets. United Kingdom takes the top spot at 25% while France, Germany and Switzerland round off the next three spots. From a sector look, financials account for the largest share at 20.9% closely followed by consumer staples (13.8%), healthcare (12.8%) and industrials (12.1%). The fund has amassed $2.3 billion in its asset base while trades in solid average daily volume of more than 1.3 million shares. It charges 45 bps in fees per year and has added 1.2% in the year-to-date timeframe.

iShares Currency Hedged MSCI EMU ETF (HEZU - Free Report)

This product follows the MSCI EMU 100% USD Hedged Index and is a play on the popular iShares MSCI EMU ETF (EZU) with a hedge to strip out the euro currency exposure. The fund holds 265 well-diversified securities in its basket and financials, industrials, consumer discretionary and consumer staples are the top four sectors accounting for double-digit allocation each. The ETF has amassed $1.1 billion in its asset base and trades in solid volumes of more than a million shares a day. The fund charges 52 bps in annual fees from investors and has returned 6.5% so far this year.  

Deutsche X-trackers MSCI Eurozone Hedged Equity ETF (DBEZ - Free Report)

This ETF follows the MSCI EMU IMI U.S. Dollar Hedged Index. Holding 670 stocks in its basket, the fund is well spread across components with each holding no more than 2.6% share. From a sector look, financials, industrials and consumer discretionary are the top sectors with a double-digit allocation each. The fund managed assets worth $49.5 million and sees lower volume of about 24,000 shares a day. Expense ratio came in at 0.45%. DBEZ is up 5.9% so far this year (read: ECB Trims But Extends QE: ETF Winners & Losers).

ProShares Hedged FTSE Europe ETF (HGEU - Free Report)

This product tracks the FTSE Developed Europe 100% Hedged to USD Index, charging 27 bps in annual fees. With AUM of $3.8 million, it holds well diversified 533 stocks in its basket with a slight tilt toward the financial sector at 20.6%, followed by consumer staples (13.6%), health care (13.1%) and industrials (12.7%). United Kingdom takes the top spot at 30% while France, Germany and Switzerland round off the next three spots with a double-digit exposure each. The ETF trades in a paltry volume of under 1,000 shares and returned 6.5% in the year-to-date timeframe.

Bottom Line

Currency hedge strategies have regained immense popularity in recent months, especially after the election. Given a weak euro and encouraging economic trends, investors could definitely look to these currency hedged ETFs. These products have a Zacks ETF Rank of 3 or ‘Hold’ rating and are expected to perform better than the traditional European funds if the euro/dollar hits parity.

Disclosure: None.

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Nick De Peyster, CFA 7 years ago Contributor's comment

And if the Eurozone breaks up such that Lira, Francs, Pesetas, etc. come back, then what?

Nick de Peyster