ETF 360: IndexIQ's Dan Petersen on Currency Hedging

“Currencies actually have quite a substantial impact on international equity investing,” Petersen said. He noted that typical U.S. investors will convert their currency into the proper one for a given market to invest in the equities there. That conversion has an impact. “It’s not just an isolated return of what happens overseas,” added Petersen.

Currencies do tend to revolve around a parity value. Unfortunately, it can be challenging to predict where they will go in the mid and long term. Speaking to the short term, Petersen said, “the choppiness short term can really destroy a holding.”

Petersen shared that many investors don’t tend to think tactically about currencies. He pointed to the hedging of Japan’s currency last decade and the bullishness on Japanese equities. Though things played out well for funds looking to take advantage, based on AUM, funds flowed in too late. “The performance happened, assets flowed into hedged products, then they underperformed,” Petersen said, adding, “I think that experience really haunted a lot of investors and advisors.” He noted that less than 1% of AUM in foreign large blend is hedged today. However, the value remains there.

“Most people don’t want to have a view or position in a passive nature when looking at ETFs, and one way to do that would be to have a 50% currency hedge.” According to Petersen, this provides the benefits of foreign currency appreciation. However, since you aren’t completely hedged, you can avoid years like 2022 — which was a problem for hedge-focused strategies. Being only 50% hedged offers some downside mitigation while still capturing upside.

“You get the best of both worlds,” Petersen said.

HFXI uses a 50% currency hedge to gain the upside of currency appreciation while hedging against the downside.

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