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Due to the incredible success of the Japan Hedged Equity Fund (DXJ - ETF report), WisdomTree has been quickly stuffing more hedged-equity products into the pipeline. Just last week the company revealed plans for a few more hedged ETFs targeting markets like Japan small caps, Great Britain, and South Korea.
While this represents a potentially big bet on the hedged-equity ETF strategy, it also appears that WisdomTree isn’t done just yet, as it has put out documents with the SEC for another product with this focus in a brand new filing. This time though, the fund looks to focus on Germany while hedging out the euro for its exposure.
Germany Hedged Equity Fund in Focus
This in-registration product looks to track the WisdomTree Germany Hedged Equity Index, a broad benchmark of German stocks without euro currency risk. The index looks to consist of dividend-paying companies that are incorporated in Germany and trade primarily on German Exchanges (read The Comprehensive Guide to German ETF Investing).
Stocks included will need to have a market cap of at least $1 billion, pay at least five million dollars annually in dividends, and see daily dollar trading volume of at least $100,000 a day. From a sector perspective, investors should note that the maximum weight of any one segment is capped at 25%, so the portfolio will not be too concentrated overall.
However, the firms included will also have to derive less than 80% of their revenues from Germany, giving a focus on exporters. This can potentially tilt the portfolio to companies that are poised to benefit from a weakened euro in their global operations.
This is because as a domestic currency weakens, it makes exports cheaper in foreign currencies. Generally, this results in a boost in purchases by foreigners, helping to add to overall returns when repatriated back to a domestic currency.
Yet, many times, stock investors from a foreign nation have to fight through a weakened currency on an equity front, a situation that is often a headwind to returns. For example, if a U.S. investor buys German shares in euros, a decline in the value of the euro against the dollar will have a negative impact on American-based returns when transferred back to U.S. dollars (see Do Country ETFs Really Provide Diversification?).
The German hedged equity fund looks to avoid this situation, seeking to outperform when local currency markets are unfavorable. However, it is also important to remember that when the local currency (euro) is firm, hedged products like this proposed one will probably underperform their unhedged peers.
How might it fit in a portfolio?
This proposed ETF could be an interesting choice for investors seeking to invest in Germany, but without worrying about the euro. This could be a welcomed addition to some, as Germany is often considered to be a strong economy but its equity prices can be under pressure for U.S. investors thanks to euro weakness.
A hedged fund could also act as a new competitor to the other Germany ETFs currently on the market. At time of writing, there is the ultra-popular (EWG - ETF report), two small cap funds (GERJ - ETF report) and (EWGS - ETF report), and then an AlphaDEX fund, (FGM - ETF report) as German ETF alternatives.
While they all provide great exposure to the German market—in various forms—they are also all unhedged as well. So, these products could outperform when the euro is firm, but they will probably lag a potential hedged product when the euro is sliding (read Are German ETFs in Trouble?).
Can it succeed?
Clearly investors have embraced the hedged exposure technique when it comes to Japan, although there are definitely some special factors for that market. Easing has reached an incredible level in that country, and it is hard to imagine the Germans and the rest of Europe embarking on a similar campaign in Frankfurt.
However, it is also worth pointing out that Japan has a similar economic strategy as Germany, with a lack of commodities and a heavy focus on exports. This means that the two might be somewhat similar in many investors’ eyes, and that a hedged currency approach could make sense in Germany as well.
Due to this, a German hedged equity ETF could be an interesting product, and it may see some decent inflows if it is ever approved. Further weakness in the euro will probably be required though, as without more a sluggish currency, investors will probably stick with the bevy of other ETF options in the German market for exposure to the important European nation.
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Author is long EWG.