Q: What is the genesis of the funds?
A : In the last decade, all of the outperformance of the developed markets actually came from the decline in dollar. In 2008, investors realized that gains in international equities were vulnerable to the strengthening dollar, and as a result U.S. investors tended to invest more of their assets overseas to gain that foreign currency exposure. Deutsche Bank and MSCI developed the idea of the currency hedged international equity indices which later evolved to exchange traded funds. There are five main baskets that we launched - emerging markets, EAFE (Europe Australasia and Far East), Japan, Brazil and Canada and they are tracked by five different funds. The db X-trackers MSCI Japan Hedged Equity Fund, the db X-trackers MSCI Emerging Markets Hedged Equity Fund, the db X-trackers MSCI EAFE Hedged Equity Fund, the db X-trackers MSCI Brazil Hedged Equity Fund and the db X-trackers MSCI Canada Hedged Equity Fund. Q: What are db X-trackers ETFs designed for? A : db X-trackers Exchange Traded Funds are an index tracking solution of Deutsche Bank AG. db X-trackers Exchange Traded Funds are passive investment funds which aim to closely track an underlying benchmark index by combining the advantages of stocks and funds in one product. Here, the ETFs are equity funds with a currency hedge overlay rather than currency strategies. db X-trackers Exchange Traded Funds offers a broad range of Exchange Traded Funds covering a range of markets including equity, bond, credit, money market, currencies, commodities and alternative asset classes.
Q: What is unique about this index?
A : The MSCI EAFE US Dollar Hedged Index (tracked by DBEF) invests in a selection of stocks from 22 developed markets that include Europe, Australia and Southeast Asia but excludes those from the U.S. and Canada and hedges 11 currencies. The product offers exposure to the MSCI EAFE US Dollar Hedged Index, which is the benchmark index with hedged currency exposures. So, to hedge out the currency exposures we use one month currency forwards and roll those on a monthly basis. We strictly track in the EAFE basket and then we hedge out the currency exposure that has been generated by that basket. The hedging is one-on-one, so there is no leverage. The idea is to neutralize the currency exposure and get as close to local market returns as we can. Hedging the currency risk creates a “pure play” on the international equity without the currency risk usually associated with international investments. This gives US investors a suite of products that enables them to access the benchmark indices in somewhat local terms.
Q: Can you discuss the other hedged ETF products?
A : Our Emerging Markets fund (DBEM) invests in the Emerging Markets MSCI Index and hedges the 21 currencies of the countries included in the basket. The Emerging Markets Index consists of indices in 21 emerging economies like Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, South Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey. We invest in the underlying equities and then hedge out the corresponding currency. In any environment we try to get the local currency return as closely as possible. The MSCI Japan Index (tracked by DBJP) is designed to track the equity market performance of Japanese securities listed on Tokyo Stock Exchange, Osaka Stock Exchange, JASDAQ and Nagoya Stock Exchange. Here we are investing in the MSCI Japan Index and then hedging out the currency exposure generated by the currencies. Japan has gone through a dramatic decline in currency value in the last two months. Since mid-November the currency has declined 14% creating a considerable head wind for investors who did not hedge the currency exposure. During the same period the Nikkei index soared nearly 30% in the local terms. The unhedged Japan tracking ETFs avoided this currency decline for investors.
Q: What happens when the trend changes and the currency start weakening rapidly? Are you able to capture returns as close to the local market returns?
A : Yes, that’s right, with the intraday liquidity of ETFs, investors now have tools to protect their investments in either scenario. I think more importantly, over the longer term, by investing in unhedged foreign equities investors are expressing a currency view and now, with our suite of products, they can decide whether or not they want to take a view on the currency. They no longer have to go short the dollar and long the foreign currencies when taking an international equity position. For an investor who doesn’t have a view on currencies, they should take the position in the equities 50% hedged and 50% unhedged.
Q: What were the hedged and unhedged returns in Canada through your index?
A : Over the past 5 years, the Canadian Dollar has fluctuated significantly against the US Dollar, most notably over 2008 and 2009. Over this period, the returns of the hedged and local indices have been quite similar, though an investor would have experienced large fluctuations, both negative and positive, in the value of their unhedged investments along the way. This raises another benefit to currency hedging, as the volatility of returns can also be reduced when removing your investments exposure to currency moves.
Q: With the euro strengthening against the U.S. dollar, how do you expect to see better results through your flexibility?
A : If the euro has strengthened we would expect, as a U.S. based investor, to have outperformed by not hedging. Again, over the last few years, we have seen big currency moves, some positive some negative for international equity strategies, hedged and unhedged. Our fund, DBEF outperformed by being hedged last year. We offer an allocation strategy at the country or regional level that allows people to take a hedged or unhedged position depending upon their view or lack of view on the currency.
Q: Are advisors using a 50:50 weighting between hedged and unhedged or do they have different strategies for it?
A : It depends, some are using it tactically for specific environments and others are using it alongside the unhedged as part of the strategic allocation.
