ETF Review: Hedged Japan and Europe ETFs Getting Bubbly? (WETF, DXJ, HEDJ, EWJ, VGK)

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24/7 Wall St. is reviewing ETF strategies, nuances and trends with regularity, and we cannot help but to wonder about the so-called hedged international exchange traded funds (ETFs). These hedged ETFs are outperforming right now due to the strength of the dollar and to concerns about the foreign central banks. We really do commend the effort here. That being said, we cannot help but wonder whether the hedged ETF strategy is getting a bit ahead of itself.

WisdomTree Investments Inc. (NASDAQ: WETF) has risen handily in value over the past year, and part of its growth has been its assets under management due to the hedged ETF strategy. With all of the funny money being created out there, this is a fresh easy way for investors to buy into an overseas stock market without having to worry about the currency risk. Two such hedged equity ETFs are worth looking at closely: WisdomTree Japan Hedged Equity (NYSEMKT: DXJ) and the WisdomTree Europe Hedged Equity (NYSEMKT: HEDJ).

WisdomTree Japan Hedged Equity (NYSEMKT: DXJ) now has reached more than $5 billion in assets as investors are chasing the Japanese quantitative easing winners (Japanese stocks) without the risk of the falling yen. Jeremy Schwartz, WisdomTree’s Director of Research, was quoted in mid-March saying:

Japanese Prime Minister Shinzo Abe has nominated Haruhiko Kuroda to succeed Masaaki Shirakawa as head of the Bank of Japan. We believe the BOJ supports bold action to potentially reverse Japan’s long-term deflationary trend, manifesting primarily in a weaker currency … We also believe that we are still in the beginning stages of a potentially big move, with ample room for the yen to further depreciate and equities to continue their gains. For some context, the Nikkei 225, a broad Japanese stock index, has to appreciate more than 50% from its current 12,000 levels to reach its early 2007 levels of 18,000, while the Dow Jones Industrial Average reached a new high and S&P 500 is almost past its all-time high.

Note that this one ETF is currently more than 20% of the firm’s assets (as of March 15). The ETF now trades at $43.50 on more than 2 million shares per day on average, and its 52-week range is $30.07 to $44.29. With shares closing out 2012 at $36.88 on an adjusted basis, the ETF is up by 17.9% year-to-date. Compare this to the iShares MSCI Japan Index (NYSEMKT: EWJ) and the result is clear: the iShares is up 10.4% and the hedged ETF is up by 17.9%.

The WisdomTree Europe Hedged Equity (NYSEMKT: HEDJ) aims to buy the European market, minus the euro currency risks. WisdomTree’s website even says:

The greatest challenge with Europe may not be its equity markets, but the euro itself. We believe the many global brands headquartered in Europe are still attractive investment opportunities. HEDJ offers you a way to capitalize on their growth potential, while hedging the effects of the euro.

This ETF is not as liquid, with only about 50,000 shares trading each day, but imagine if the European Central Bank ever decides to get on with the devaluation program in a stronger manner that involves the printing presses like you have seen in Japan (or the United States for that matter). The “we’ll do whatever it takes to preserve the euro” leaves many open-ended promises and possibilities that have to be fulfilled.

This ETF is at $50.10, and its 52-week range is $38.94 to $51.19. With its shares closing 2012 at $47.66 on an adjusted basis, this ETF is up by 5.1% year to date. Compare it to the Vanguard MSCI Europe ETF (NYSEMKT: VGK) and the result is clear: The Vanguard ETF is up only 1.3%, versus a 5.1% for the Wisdom Tree hedged version.

If you look at the outperformance, it is not so extreme that we are panicked or anything. Many investors still do not even know that these ETFs exist. That being said, we would be mindful of these as currencies can reach extreme levels, and our take is that all major countries are either printing money now or at severe risk of doing so in the future. These ETFs may continue to perform similarly, relative to the traditional unhedged ETFs. There also has to be a reminder that nothing lasts forever, and when the trend changes or gets too out of line, the snapback will not be pretty.