A King Among Currency-Hedged ETFs

Few exchange traded funds have benefited from the currency-hedged boom in similar fashion to the Deutsche X-trackers MSCI EAFE Hedged Equity ETF (NYSE:DBEF). Year-to-date, only one ETF has added more new assets than the $13.1 billion hauled in by DBEF.

Inflows to this year's eighth-, ninth- and 10th-best asset-gathering ETFs would have to be added up to arrive at a sum that exceeds DBEF's 2015 inflows. Although the Federal Reserve eschewed raising interest rates following its September meeting, punishing the dollar in the process, DBEF has kept its momentum going. The ETF added nearly $2.4 billion in new assets during the third quarter, tops among currency hedged funds and a total exceeded by just four other ETFs.

Prior to 2015, DBEF had minimal assets despite launching in late 2011. We think interest in DBEF is the result of investor attention on the U.S. dollar strength in 2015 relative to the euro and other major currencies. The ETF holds securities in major developed markets, but hedges out the impact (favorable or unfavorable) of the local currencies and tracks a US dollar hedged index, said S&P Capital IQ in a note out Thursday.

The research named DBEF its focus ETF for October. DBEF is worthy of that designation when considering the ETF has traded modestly higher over the past year while the unhedged MSCI EAFE Index has tumbled more than 8 percent. DBEF follows the MSCI EAFE US Dollar Hedged Index. Importantly, DBEF has been superior on a risk-adjusted basis as well.

DBEF also ranks favorably to S&P Capital IQ for a number of ETF level attributes. The ETF's standard deviation at the end of August of 9.7 is modest and is 15% lower than EFA. Meanwhile, the ETF has a 0.35% expense ratio and trades with a relatively tight bid/ask spread. Over the last three months, DBEF has traded 4.7 million on a daily basis, said S&P Capital IQ.

Diverging developed market monetary policies increase DBEF's allure. Some investors are still betting the Fed will raise interest rates in the coming months, perhaps as soon as this month. Conversely, the Bank of Japan and the European Central Bank are seen as having the room to add to their already massive easing programs. Combined, Japan and the Eurozone account for over 45 percent of DBEF's geographic weight.

That does not include DBEF's solid exposure to Nordic countries, some of which have room to lower rates. In fact, Norway, which is featured in DBEF, recently did just that.

Eurozone GDP growth was slightly slower in the second quarter (0.4%), compared with the first quarter (0.5%), but leading indicators suggest that activity has remained steady since then. They believe the European Central Bank will extend its QE program beyond September 2016, most likely until mid-2018, and that it could reach EUR2.4 trillion - more than twice the original EUR1.1 trillion commitment, said S&P Capital IQ.

The research firm has an overweight rating on DBEF.