Exchange-traded products have permanently changed the investment industry by giving advisors and their clients access to an ever-evolving range of exposures and strategies that were previously only available to institutional pools of capital.
This has been especially true with how foreign investments are utilized. Ten years ago, ETF selection was limited to funds tracking broad indexes like the MSCI EAFE Index and a handful of single country funds, as no individual ETF yet existed that invested in foreign bonds or currencies.
A broadening array of equity funds eventually provided access to relatively smaller countries. Specialty equity funds brought exposures to narrower foreign sectors, themes and niches in both developed and developing markets. This was soon followed by foreign fixed income funds and then currency ETFs.
As these new funds began to proliferate in the last decade, advisors and their clients aggressively sought their application because the U.S. dollar was generally going down against many other currencies. This had the effect of boosting returns for U.S. investors.
Just as investment products have evolved, so too have markets. Lately, the U.S. dollar has gone up against many currencies contributing to the general underperformance of developed and emerging markets.
The ensuing currency drag led to the wave of innovation that is currency hedged equity funds. There are at least 20 equity ETFs that hedge or neutralize the currency exposure, and these funds have quickly gained mass. The largest fund in the niche contains more than $12 billion in assets.
The performance difference when hedging out the currency can be meaningful. In 2013, the WisdomTree Japan Hedged Equity Index was up 54% versus just 27% for the MSCI Japan Index. Most of that difference is attributable to the yen's unexpected 20% decline, which is huge by currency standards.
