WisdomTree Investments, Inc. (WETF - Snapshot Report), the largest player in the money management domain specializing in exchange traded funds (‘ETF’), has registered a year-to-date return of 38.4%. The uptick was driven by growth in the company’s currency-hedged funds, particularly focused on Japan and Europe.

A strong dollar environment, attributable to ongoing quantitative easing programs by European Central Bank and Bank of Japan, has made currency-hedged ETFs popular among investors seeking to put money in the growing equity markets of Europe and Japan. Notably, The Stoxx Europe 600 Index gained 16%, while the Nikkei-225 Stock Average climbed 8.8% in 2015.

Growth Story

WisdomTree’s two primary currency-hedged ETFs − WisdomTree Europe Hedged Fund (HEDJ) and WisdomTree Japan Hedged Equity Fund (DXJ) – have largely outpaced their un-hedged counterparts in terms of returns. As per data compiled by Bloomberg, HEDJ has recorded an 18% gain over the past six months compared with a negative 5.3% return generated by traditional iShares Europe ETF; while year-to-date, DXJ has managed to return 11.96%.

Further, HEDJ and DXJ attracted $7.4 billion and $2.2 billion funds, respectively, so far this year. Moreover, the company recently launched WisdomTree Japan Hedged Dividend Growth Fund (‘JHDG’) to capitalize on expected growth in dividends driven by strong performance of Japanese equities, hedging the currency risk at the same time.

Is the Growth Sustainable?

Quite evidently, currency ETFs have managed to gain acknowledgement in combating volatility in the short run. However, in the long run, when interest rate parity holds good, the functionality of hedging to curb volatility will become questionable.

GMO White Paper, which hedges currency risk for investments in fixed income, argues on the use of currency hedging in equity investments. It states that in an era of globalization, where costs and revenues are denominated in multiple currencies, shorting a local currency while making equity investments will only lead to additional risk of leverage, instead of reducing exposure.

Further, it argues that such practice is not viable in reducing volatility of global equity portfolio, since hedged equities have been found to have relatively stronger correlation with U.S. equities compared with their un-hedged counterparts.

Bottom Line

Though questions have been raised over the sustainability of the performance of Wisdom Tree’s currency-hedged ETFs, we cannot fail to acknowledge the fact that such funds have indeed managed to attract and provide investors with solid returns. And as the dollar strengthens, this trend will likely continue in the near term as well.

However, concerns over the economic relevance of such funds in the long term makes us wary regarding their future prospects.

Currently, Wisdom Tree holds a Zacks Rank #2 (Buy). Some better-ranked stocks in the finance space include Arlington Asset Investment Corp. (AI -Snapshot Report), Cowen Group, Inc. (COWN - Snapshot Report) and Silvercrest Asset Management Group Inc. (SAMG). All these stocks sport a Zacks Rank #1 (Strong Buy).