IHDG - DBEF: A Hedge With 2 Faces

2023-12-04 07:15:36 ET

Summary

• Xtrackers MSCI EAFE Hedged Equity ETF is a large-cap ETF invested in developed markets excluding the US and Canada.
• The fund intends to offset currency risks.
• The ETF is well-diversified across countries, sectors, and holdings.
• Equity ETFs with a currency hedge involve two bullish bets, on an equity strategy and the USD.

Fast facts and strategy

Xtrackers MSCI EAFE Hedged Equity ETF (DBEF) is a passively managed ETF tracking the MSCI EAFE US Dollar Hedged Index. It was listed on 06/09/2011. As of writing, it holds 816 positions: 790 stocks, 14 stock index futures, plus 12 short positions in foreign currencies (long USD), so as to offset the currency risk on stock holdings. The fund has a total expense ratio of 0.36%. Distributions are paid semi-annually, and we will see that they may vary a lot, so don't rely too much on the trailing yield as a reference.

As described by MSCI , the underlying index " is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada ".

The index also aims at neutralizing exposure to fluctuations between the value of foreign currencies and the U.S. dollar.

Do you really want this hedge?

The currency hedge adds some complexity to the fund's price behavior. The idea of the hedge is that if Japanese holdings gain +10% in JPY, this part of the fund gains +10% in USD, whatever the Yen does.

If you think the US dollar will stay strong or become stronger relative to the Euro and the Japanese Yen (the heaviest currencies in the portfolio), then you want this hedge. Remember what I wrote in the first paragraph: DBEF has short positions in the local currencies of the companies held in the portfolio. It means it is long USD against these currencies.

However, currency risk has two faces. If you have a doubt about the strength of the dollar, or if you seek diversification with plain exposure to foreign economies, then you'd better choose a non-hedged fund.

There is another level of risk related to currencies, not covered by the fund's currency hedge. A stronger dollar may be beneficial to a foreign company's sales because their products and services become cheaper in USD, and it may also be detrimental when providers or creditors must be paid in USD.

Portfolio composition

DBEF is mostly invested in large and mega-cap companies (89% of asset value) and in Europe (about 62%). Japan is the heaviest country by far (22.4% of assets), followed by the UK (13%), France (11.6%), Switzerland (10%) and Germany (8.5%). The next chart plots the countries weighing more than 1%, representing 93% of asset value in aggregate. Hong Kong weighs 2.1%, so direct exposure to geopolitical and regulatory risks related to China is low.

The fund is well-diversified sector wise: no GICS sector weighs more than 20%. The heaviest one is financials (18.3% of assets), followed by industrials (15.2%).

The fund is well-diversified across holdings also. The top 10 names, listed below, represent only 14.7% of asset value. Moreover, the heaviest one weighs about 2%, so risks related to individual companies are low.

DBEF vs. international hedged ETFs

The next table compares the characteristics of DBEF and two other hedged international ETFs:

• WisdomTree International Hedged Quality Dividend Growth Fund ( IHDG )
• iShares Currency Hedged MSCI EAFE ETF ( HEFA )

DBEF is the oldest, largest (in assets), and most liquid fund of the group. It is behind HEFA in 4-year average yield and behind IHDG in 5-year dividend growth. However, distributions include hedging gains, which makes metrics based on recent distributions quite unreliable.

As plotted on the next chart, the 2022 distribution was an outlier, skewing the averages. Based on distributions between 2014 and 2021, the average yield with the current price would be closer to 3%. Moreover, the dividend growth in this period was negative.

The next chart plots total returns starting on 5/12/2014 to match all inception dates. IHDG has been the best performer, but the difference in annualized return is not very significant (7.7% vs. 8.1%). DBEF and HEFA are based on the same underlying index, which explains why their paths are almost identical.

However, DBEF and HEFA are slightly ahead in 2023 to date:

It makes little sense to compare DBEF with non-hedged ETFs. The last 10 years have been characterized by a dollar bull market: the dollar index ( DXY ) has gained about 29% since 2014. It is a large bias when comparing hedged and non-hedged funds. The dollar is more likely to go sideways or a bit down in the next few years than to continue on the same slope.

To illustrate this point, the chart below compares DBEF with its non-hedged underlying index, represented by iShares MSCI EAFE ETF ( EFA ).

Takeaway

Xtrackers MSCI EAFE Hedged Equity ETF is a large-cap ETF invested in developed markets excluding the US and Canada. It is well-diversified across countries, sectors, and holdings. The currency hedge aims at projecting the performance measured in local currencies to a performance in the dollar. It involves a number of embedded currency trades. It is supposed to offset the currency risk for USD-based investors. However, currency risk may be beneficial. Equity ETFs with a currency hedge involve two bullish bets, on an equity strategy and the USD.

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