HEFA ETF: Hedging International Currency Risk Away (BATS:HEFA)

Investing in international stocks exposes investors to currency risk, which arises from fluctuations in the exchange rate between two currencies. When an investor from one country buys stocks in a foreign market, the returns on that investment can be significantly affected by changes in the value of the foreign currency relative to the investor’s home currency. For example, if the foreign currency depreciates against the investor’s home currency, the value of the investment and any dividends received will decrease when converted back to the home currency. Hedging currency risk is crucial as it allows investors to protect their international investments from this volatility. By using financial instruments such as options, forwards, and futures, investors can lock in exchange rates or minimize the impact of adverse currency movements, thereby securing the actual value of their returns and aligning it more closely with the underlying performance of the assets they have invested in.

For those that don’t want to worry about currency movement impacting their international allocations, the iShares Currency Hedged MSCI EAFE ETF (BATS:HEFA) is worth considering. This is a fund that offers exposure to international equity markets while mitigating currency risk. Launched on January 31, 2014, HEFA is designed to track the investment results of an index consisting of large- and mid-capitalization equities in Europe, Australasia, and the Far East. The fund simultaneously hedges against fluctuations between the component currencies and the U.S. dollar. The fund’s net assets as of now are approximately $3.9 billion. It operates on the Cboe BZX Exchange, formerly known as BATS, under the ticker symbol ‘HEFA’. The expense ratio for the fund is 0.35%.

ETF Holdings

The primary holding of HEFA is the iShares MSCI EAFE ETF, which makes up a whopping 97.46% of the fund’s portfolio. The rest of the holdings include cash and various currency forward contracts. The currency forward contracts serve the purpose of hedging and are designed to offset the fund’s exposure to foreign currencies.

Sector Composition

The fund’s sector composition provides a clear picture of which sectors the fund is most exposed to. The top sectors include Financials (18.38%), Industrials (15.93%), Health Care (12.62%), and Consumer Discretionary (11.64%). The other sectors include Consumer Staples, Information Technology, Materials, Energy, Communication, Utilities, Real Estate, and others.

Peer Comparison

When compared to other similar ETFs, HEFA stands out for its unique strategy of hedging currency risk. This feature is especially beneficial for investors who wish to invest in international markets without the added risk of currency fluctuations. This is an important point. If you want to express a view on international equities, why muddy it with currency fluctuations? The worst thing that could happen is you’re right about the international equities rising while the currency conversion takes away from that. For this reason alone, hedged EFA is better and more pure than unhedged EFA.

Pros and Cons

Investing in the iShares Currency Hedged MSCI EAFE ETF (HEFA) comes with its own set of advantages and disadvantages.

Pros

1. Currency Risk Hedging: The fund’s strategy of using currency forward contracts to hedge against currency risk is its unique selling point. This strategy allows investors to invest in international markets without worrying about the impact of currency fluctuations on their returns.

2. Diversification: The fund offers exposure to a broad range of companies in various sectors and countries, providing excellent diversification benefits.

3. Liquidity: With net assets of over $3.9 billion, the fund is quite large and highly liquid. This makes it easier for investors to buy and sell shares without impacting the price too much.

Cons

1. Fee Structure: With an expense ratio of 0.35%, the fund is more expensive than many other ETFs that offer exposure to similar markets.

2. Currency Hedging Limitations: While currency hedging can protect against currency risk, it can also limit potential gains when the U.S. dollar weakens against foreign currencies.

Conclusion

The forecasted policy rate adjustments by the US Federal Reserve, which include a gradual decrease to a target range of 4.00%-4.25% by the end of 2024, may have a mixed impact on European stocks and the Euro. On the one hand, lower US rates could weaken the dollar and potentially strengthen the Euro, making European stocks more attractive to foreign investors. Conversely, if the decrease in US rates reflects concerns about global economic growth, it could dampen investor sentiment worldwide, potentially leading to reduced risk appetite and a pullback from equities, including European stocks.

Additionally, the impact of earnings drift in high-growth sectors and market valuation will be important; robust earnings in these sectors could support European stock market growth, while market valuations that are attractive relative to other regions could draw international investment, benefitting both European equities and the Euro. The point here is that investing in equities is complex enough from a scenario analysis, so why bother thinking about currency movement and being affected by it? Because of that dynamic alone, I like HEFA. It can be an effective way to gain exposure to international equity markets while mitigating currency risk. However, investors should be mindful of the fund’s fee structure and the potential limitations of its currency hedging strategy.