On June 9th the first Emerging Market Equity ETF that is 100% USD currency hedged made its debut on the New York Stock Exchange. It is the Deutsche Bank-MSCI Emerging Markets Currency-Hedged Equity Fund (NYSE: DBEM )

Up to this point all Emerging Market Equity ETFs and mutual funds were straight plays on emerging market equities with the risks (and rewards) inevitably tied to the currency swings of the emerging countries versus the US Dollar. Many investors over the past decade embraced this emerging currency exposure as they sought both the advantage of owning the foreign equities along with an appreciating emerging currency kicker.

This works well during bull markets as the dollar tends to decline as risk assets (such as emerging equities) rise. This provided a ‘Beta boost’ and added to the returns of risk assets up and above the underlying equity exposure. However this boost turns into a large drag when things turn ugly.

If an investor held a traditional Emerging Market Equity ETF such as Ishares Emerging Markets (NYSE: EEM ) or Vanguard Emerging Markets (NYSE: VWO ) during the 2008 crash, they would have experienced the double whammy of accelerated emerging equity selling along with the significant drag of the strengthening dollar. And during very stressful times the US Dollar is still seen as a safe haven (despite a negative S&P US debt review) and does tend to increase in value.

This phenomenon is counter to the benefits of diversification with respects to traditional Emerging ETFs such as EEM and VWO falling 49% and 53% respectively during 2008 while the SP500 fell around 38%. The US dollar rose 18.7% between Aug 1 2008 and Dec 1 2008 harming foreign funds more during the exact time you needed diversification the most.

This pattern remains today, where on a daily basis when risk assets decline in value the US Dollar tends to rise and vice versa.

Deutsche Bank, with the development of DBEM, allows participation in the pure growth of the emerging equities without any effect of currency movement. This creates a lower volatility vehicle to gain access to emerging equities with no currency risk. It will however be more correlated to the SP 500 than a traditional emerging equity product.

A falling US Dollar greatly aided returns to emerging markets in the past and if you do not mind shorter term volatility and continue to think the US dollar will decline you still would be better off to stay with traditional plays like EEM and VWO.

However if you want to lower risk within a portfolio and feel the dollar might be bottoming around current levels (especially with the risk of slowing emerging market growth, flat emerging yield curves, and high inflation) currency hedged pure emerging equity exposure can make sense.

The Deutsche Bank-MSCI Emerging Markets Currency-Hedged Equity Fund (NYSE: DBEM ) is very illiquid at this point and carries an expense ratio of 0.65%.

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