forex

Bloomberg News

Investors are hedging their bets against more wild currency moves.

Nearly half of all inflows into U.S.-listed exchange-traded funds this year have been invested in currency-hedged products, according to ETF.com. A total of $10 billion has entered 35 currency-hedged funds in 2015, amounting to 49% of the $20.4 billion that all ETFs had gathered as of Friday, the firm said.

Such funds have been available for several years, but have become increasingly popular as of late as the U.S. dollar appreciates. In the first six weeks of 2015, the funds have collected nearly 30% of their total asset base.

Matt Hougan, president of analytics and publications at ETF.com, expects currency-hedging to be a defining theme of 2015. It’s the number one topic of discussions at conferences and among advisers, he says.

Tom Lydon, ETF Trends editor and publisher, agrees. He says we may only be in the early innings of inflows into these products as there could be potentially greater currency divergence over the next several years.

A currency-hedged ETF may sound confusing, but it’s fairly simple: It strips out any foreign-exchange effect, essentially acting as a currency neutralizer. Performance abroad is kept in local currency terms versus having to be converted back into dollar terms. European currency-hedged funds, for example, have become particularly popular because of the falling euro, rising U.S. dollar and advancing local stock market.

Among the currency-hedged ETFs collecting the most money this year are WisdomTree’s Europe Hedged Equity ETF, Deutsche Bank’s X-trackers MSCI EAFE Hedged Equity fund and BlackRock’s iShares Currency Hedged MSCI EAFE product. While investing in all three protects against currency fluctuations, each fund in a little different.

The WisdomTree Europe Hedged Equity fund tracks an index developed internally at ETF issuer WisdomTree that is heavily tilted toward Eurozone dividend-paying exporters. It’s a bet that the euro will depreciate against the greenback and that exporters will outperform on the back of a falling euro. This fund has seen the largest inflows across all U.S.-listed ETFs this year, collecting $4.1 billion in 2015 – roughly 40% of its total assets. Mr. Hougan cautions investors should think about this ETF as a long-term play – say, over the course of a year – instead of as a short-term trade because individual sector outperformance can overwhelm the fund during a small time span.

Deutsche Bank’s X-trackers MSCI EAFE Hedged Equity ETF tracks a broader index than WisdomTree’s fund, following mostly large-cap developed-market equities. European stocks account for roughly half of the fund’s holdings and Japan equities make up about 20%. This ETF has seen inflows of $2.1 billion this year, putting it in the top 10 of all U.S.-listed ETFs by inflows.

BlackRock’s EAFE currency-hedged ETF tracks the same index as Deutsche Bank’s product. BlackRock’s fund debuted only a year ago and has a little under $1 billion in assets – $856.2 million, or 91%, of which have come from this year alone. It’s a little less liquid than Deutsche Bank’s ETF, which has greater average daily dollar volume and a fractionally tighter spread.

When it comes to investing in currency-hedged products, investors should know that currency-hedging isn’t attractive in every market. It works in Europe because interest rates are lower there than in the U.S. essentially making it better than free. In some emerging markets, where interest rates are higher, U.S. investors would have to swallow the cost of higher rates to get currency-hedged exposure.

Some advisers recommend that instead of investing whole-heartedly into currency-hedged products, investors split parts of their foreign stock exposure down the middle with half going into non-currency-hedged ETFs and the other half going into currency-neutralized products.