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Look out: Currency hedging is on the loose in ETF world

That stampeding sound you hear is coming from fund managers scurrying to get into the currency-hedging trade.

In recent weeks firms have brought more than a dozen new offerings in that category to the exchange-traded fund universe. ETFs looking to hedge exposure to currency issues across Europe, South America and Asia have blossomed as investor money pours into the strategy.

As is often the case on Wall Street, the natural worry is whether the rush might come too late. Foreign exchange dynamics present earlier this year have abated somewhat, making the need to protect against currency movements less urgent for the moment.

"There were enormous flows in January, February and March. Those have tailed off a little bit," said Matt Hougan, CEO at ETF.com, a site that tracks industry trends and provides education for those using the increasingly popular products. "This is sort of a long-term theme that will be with us the next couple of years as people put currency more squarely in focus."

In terms of fund flows, four of the 10 most popular funds for the first half of 2015 involved currency hedging, as shown in the table:

Big winners in currency hedging

Ticker
Fund
Flows through 6/30/15 ($B)
Assets under management ($B)
HEDJ Wisdom Tree Europe Hedged Equity $13.97 $19.76
DBEF Deutsche MSCI EAGE Hedged Equity $10.46 $12.15
EFA iShares MSCI EAFE $5.88 $60.94
VTI Vanguard Total Stock Market $4.77 $56.15
VOO Vanguard S&P 500 $4.67 $32.28
DXJ Wisdom Tree Japan Hedged Equity $4.18 $18.15
EWJ iShares MSCI Japan $3.24 $19.59
VGK Vanguard FTSE Europe $2.78 $14.24
EWG iShares MSCI Germany $2.71 $7.18
HEFA iShares Currency Hedged MSCI EAFE $2.66 $2.72
Source: ETF.com

Despite weak returns in the second quarter, the strategy remains the most popular this year in the $2.12 trillion ETF space.

All four of the biggest asset gainers are positive for the year, but negative over the past three months. The DXJ Japan-hedged fund is the best of the group, with a loss during the span of 3.1 percent as of early Wednesday trading. HEDJ is off 10.9 percent during the period, while DBEF is down 8.9 percent and HEFA has dropped 7.9 percent.

Significant moves over the past year in the U.S. dollar, yen and euro that accompanied shifts in central bank policy are driving the desire to get in on the trade.

"What it's done is put currency in the minds of investors," Hougan said. "They're going to continue to think about whether they should be currency-hedged or not."

The funds employ various strategies to hedge against currency movements, dependent largely on whether the individual countries have economies focused more on importing or exporting.

For instance, the HEDJ Europe-focused fund tracks dividend payers that rely on exports, providing payoffs on euro weakness for U.S. investors. A strategy that focused merely on the companies in the index would have returned less than 6 percent through June 30; with the hedging aspect, though, the fund was up more than 14 percent.

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Such returns have provided bait for big ETF firms to jump into the game.

BlackRock, which is the biggest player in the industry with $813.1 billion worth of ETFs under management, added 11 new currency-hedged funds last week, bringing its total offerings in the family to 16 funds. Among the new funds are those focused on Australia, Mexico and South Korea.

State Street, the third-biggest firm with $411.7 billion in ETF assets, recently added its own fund that also protects against euro weakness. WisdomTree, the fifth-largest player with $61.8 billion in assets, opened two new funds recently focusing on small-cap and global stocks.

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There even have been some exotic funds entering in the space, with Direxion ($9.3 billion in ETF assets) adding two double-leveraged ETFs that hedge against euro and Japanese yen fluctuations.

With the race to the bottom heating up among global central banks, it's no wonder fund managers are looking to capitalize.

"With the huge central bank activity and aggressive direct intervention in their currencies, it's made currencies something you can't ignore," Hougan said. "You used to be able to have just one view. Now you have to have two views: Should I invest in Europe, and should I invest in the euro?"