An international trade that once looked like a no-brainer has turned into a major headache.
The WisdomTree Japan Hedged Equity Fund (DXJ), which combines a long position on Japanese stocks with a short position on the Japanese yen, sounds like a niche product. But as that trade played out beautifully over the past few years, with Japanese stocks soaring as the yen tanked, the ETF has become downright mainstream.
In 2009, the ETF enjoyed average daily volume of just 10,000 to 20,000 shares. By 2012, about 200,000 shares were being traded each day. The DXJ rallied tremendously in the next half a year, and by mid-2013 was seeing about 7 million to 8 million shares trade daily, a pace it has maintained up to the present.
The product plays into a popular macro thesis: Expansive policies from the Bank of Japan should help Japanese stocks and hurt the yen. This trend indeed played out powerfully for a time, leading the DXJ to nearly double from November 2012 to June 2015.
But the good times didn’t last. In the eight months after hitting that June peak, the ETF lost nearly all of its gain, falling back to its lowest level in more than three years. This as both legs of the trade failed, with Japanese stocks sliding and the yen strengthening amid a global sell-off in risk assets.
What may make this especially frustrating is that Japanese monetary authorities haven’t exactly given up on their plan to send the yen lower in order to foster long-dormant inflation and to boost exports. To the contrary, the BOJ has introduced a negative interest rate policy — which utterly failed in halting the yen’s rise. In fact, the currency is enjoying its best week in years.
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Some think it’s time to play the product for a bounce; Cowen’s head of equity sales trading, David Seaburg, said Thursday on CNBC’s “Trading Nation” that “I do like it for a near-term trade — I’d look to buy some here just because sentiment has become completely negative here.”
But others say that retail investors never should have gotten involved in such a complex product.
By buying a “currency-hedged” ETF, “you’re actually making two active investment decisions — one on the direction of the currency, and one on the underlying assets. Whenever you double your implied bets, you lower your odds of success, because you have to be right twice to win,” said Boris Schlossberg of BK Asset Management, in a phone interview, basing his assumption on the insight that each single bet made by an inexperienced investor tends to be a poor one.
The counterpoint here would be that combining one’s equity long with a currency short is a more “pure” way to play a foreign market than simply buying the stocks. If one simply buys stocks trading in Japan, for instance, it implies a long position on the yen, because one must sell dollars and buy yen in order to purchase those stocks. “Don’t layer currency risk on top of equity exposure,” warns a white paper from WisdomTree.
But Schlossberg, a currency trader and strategist, retorts that while currencies of developed countries are volatile, they do tend to stay within a band for very long periods of time. For that reason, if an investor has a horizon of one to three years, it would be wise to ignore the fluctuations, and “focus on the underlying value of the asset you actually want to own,” he said.
“Investing is hard enough” without mixing a currency trade into your international equity bet, Schlossberg argues.