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Japan ETF Will Hedge Currency Risk

As mentioned before, DXJ will continue to hold a portfolio of Japanese stocks, but starting April 1 the fund will offset the currency risk to Japanese yen by selling forward contracts. If DXJ had been using this strategy in the past month, it would have returned something closer to the MSCI Japan Index's 8.2% return, instead of 4.4%.

Earlier this year, WisdomTree launched the WisdomTree International Hedged Equity Fund (HEDJ). The portfolio is the same as WisdomTree DEFA Fund (DWM) but comes with currency protection. DWM charges 0.48% in fees, while HEDJ charges 0.58%, an added cost of 0.1% for currency protection against multiple currencies. The cost to investors for this currency protection is nothing. For DXJ, there's only one currency to hedge, and the yen is one of the most widely traded currencies in the world.

The new hedged ETF option increases the choices for investors. Let's look at four possible scenarios.

When both a nation's currency and its stock market rise, investors can buy an unhedged foreign stock ETF and gain exposure to both. The updated DXJ, however, will be a bad choice in this scenario because the foreign investor will give up currency gains.

When a nation's currency and its stock market fall, investors want to hold neither stocks nor currency.

When a nation's currency falls but its stock market rises, investors previously might have chosen to stay out of that market, because the currency decline could overwhelm the rise in stocks. However, with DXJ, investors can benefit from a rise in Japan's stock market while avoiding losses from a decline in the yen.

In the final scenario, a nation's currency rises but its stock market falls. In this case a fund like DXJ will suffer the largest losses, because it will be hurt by the currency change and by the declining value of the stocks. In such a case, investors will either want to stay out of the market or hold only the currency.

Lastly, one interesting use for DXJ would be if Japan enters a period of hyperinflation. Japan's large debt burden, which has grown during a 20-year period when the economy has basically been stagnant, has some investors wondering whether serious inflation is in the country's future.

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SYM TRADE IT LAST %CHG
EWG $30.10 0.87%
HEDJ $66.37 0.35%
DXJ $54.61 -0.93%
DWM $52.01 0.41%
FXY $81.29 0.33%

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