These Currency Hedged ETFs Could Enjoy 2016

Broadly speaking, this has been a banner year for currency hedged exchange traded funds. If they were not already, currency hedged ETFs have gone mainstream thanks in large part to the fact that no ETFs have matched the asset-gathering proficiency of the WisdomTree Europe Hedged Equity Fund HEDJ and the Deutsche X-trackers MSCI EAFE Hedged Equity ETF DBEF this year.

As their names imply, HEDJ and DBEF are multi-country funds. Looking at single-country currency hedged ETFs, particularly when excluding Japan funds, reveals varying degrees of success. For example, this has been a trying year for U.K. ETFs that hedge pound/dollar risk.

Despite the fact that the CurrencyShares British Pound Sterling Trust FXB has lost 3.3 percent year-to-date, the Deutsche X-Trackers MSCI United Kingdom Hedged Equity ETF DBUK and the WisdomTree United Kingdom Hedged Equity Fund DXPS are off an average of 5.7 percent.

There are indications that 2016 could bring better tidings for DBUK and DXPS, including FXB's 90-day loss of nearly two percent. Sterling recent bout of weakness has some market observers calling for much more of the same next year.

“With a prediction the pound will weaken a further 15 percent by the end of next year, Deutsche Bank AG is among the biggest skeptics. The second-largest foreign-exchange trader sees sterling sliding to a level unseen since 1985, the year the Plaza Accord was signed,” according to Bloomberg. 

Previously, currency traders believed the Bank of England would be one of the first developed market central banks after the Federal Reserve to raise interest rates, but wagers to that effect have dwindled. Now, with the Fed poised to raise rates and BoE on hold, calling for further pound weakness is not a stretch. However, that does not mean DBUK and DXPS are sure things heading into 2016.

Both ETFs could use a rebound in oil prices, which does not appear likely to materialize, to move higher. DBUK has an almost 13 percent weight to the energy sector while DXPS devotes 15.8 percent of its weight to energy stocks. In both cases, Royal Dutch Shell Plc (NYSE: RDS-A) and BP Plc BP are major holdings.

Other names in both ETFs that U.S. investors are likely to be familiar with due to New York listings include AstraZeneca Plc AZN, HSBC Holdings Plc HBC and Vodafone Group Plc VOD. Still, DBUK and DXPS are responsive to pound weakness. As FXB has slid lower over the past three months, the two currency hedged ETFs are up an average of 3.2 percent over that period. The pair could also rally into year-end if options traders are correct.

“Options also suggest the pound will extend its 4 percent decline versus the greenback this year. The difference between the cost of three-month contracts allowing traders to sell the pound versus the dollar and those to buy widened to a five-month high of 0.88 percentage point, from as little as 0.26 percentage point in mid-October,” according to Bloomberg.