The Better ETF Way To Europe

Hedged currency funds have proven to be one of the popular sub-segments of the ETF universe in 2013.

That much is highlighted by the fact that the WisdomTree Japan Hedged Equity Fund (DXJ) is the world's leading ETF in terms of 2013 inflows.

The statistics highlight the allure of the U.S. dollar/Japanese yen featured in DXJ. On February 7, the ETF had $2.8 billion in assets under management. DXJ entered trading Thursday with over $5.4 billion in AUM, according to WisdomTree data.

For all of DXJ's success, it should be noted that this ETF is not the only game in town when it comes to viable plays on hedging global currency fluctuations. Investors can, and arguably, should look to apply the hedged currency strategy to other regions of the world.

"Oftentimes, U.S. equities appear less volatile than international equities—not because of volatility in their actual equity price movements, but rather because of the respective currency's movements against the U.S. dollar," said WisdomTree Research Director Jeremy Schwartz in a new research note.

Schwartz highlighted the advantages of hedging euro exposure, which investors can do with the WisdomTree Europe Hedged Equity Fund (HEDJ).

As WisdomTree points out, HEDJ is "designed to have higher returns than an equivalent non-currency hedged investment when the value of the U.S. dollar is increasing relative to the value of the euro, and lower returns when the U.S. dollar declines against the euro."

Said another way, HEDJ is to EUR/USD what DXJ is to USD/JPY.

Obviously, investors will want to know if HEDJ has held up well in the face of fears about Cyprus and increasingly poor economic data out of the Eurozone. Indeed, the ETF has done just that. HEDJ has traded slightly higher over the past month while the Vanguard FTSE Europe ETF (VGK) and the iShares MSCI EMU Index Fund (EZU) are both modestly lower. Neither VGK nor EZU offer a euro hedge.

Schwartz notes that removing euro risk from the equation significantly reduces the volatility investors are subjected to.

"Removing the euro risk from the equation significantly lowered the beta of European equities compared to U.S. equities," he said. "It is worth noting that for the 10-year period ending February 28, 2013, exposure to the euro increased the beta of European Equities by nearly 40%. Over shorter periods, this additional risk was even more pronounced."

As for HEDJ, only recently have some folks become aware of this ETF's stellar asset growth, though some presciently highlighted inflows to HEDJ as far back as October 2012.

Back then, and it may not sound like much, but HEDJ saw its AUM total rise to almost $22 million from $13 million in early September.

The inflows coincided with WisdomTree overhauling HEDJ from an ETF with multiple region and currency exposures to a fund focused almost entirely on Eurozone dividend payers and hedging the common currency.

As DXJ does with Japan, HEDJ screens possible constituents to ensure the fund's holdings are not heavily dependent on the Eurozone for the bulk of their revenue. If treatment of DXJ is any indicator, many investors will overlook this important factor, opting to focus more on HEDJ's euro hedge. Still, the focus on companies that generate most of their sales overseas as a critical feature in both DXJ and HEDJ.

After all, there is no getting around the fact that Japan's domestic economy faces myriad challenges and it could be a while before the Eurozone offers investors any semblance of economic growth.

Whatever investors' motivations may be, recent returns and inflows speak for themselves. On January 29, HEDJ had $39.4 million in AUM. Today that total is nearly $186 million.

BY The ETF Professor