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Macro Alerts
Bullish German exporters, bearish euro? How UK investors can implement a GBP currency hedged equity strategy in one trade
21 mai 2015
Viktor Nossek , Director of Research


WisdomTree’s German Equity UCITS ETF – GBP Hedged (DXGP) offers UK investors German equity market exposure and potentially achieve DAX equivalent performance in GBP terms An Export-tilted German equity portfolio that is hedged in GBP efficiently positions the UK investor around euro devaluation The weakness and/or volatility of the euro may remain a recurring risk in the face of Eurozone’s macro uncertainty and the interest rate premium UK Gilts offer over German Bunds In a macro environment where divergent monetary policies place persistent pressure on a foreign currency to which local investors have an undesired exposure - when all what is desired is the return on the underlying asset - it is worth paying attention to hedging the currency risk.

In the face of UK’s improving growth conditions and rising interest rate expectations that contrast a lacklustre performing Eurozone economy requiring low borrowing costs, UK investors investing in Eurozone assets remain subject to potentially significant devaluation risk of the euro relative to the pound. Especially when seeking to benefit from the sentiment boost Europe’s export-led equity markets typically enjoy when the euro devalues, a currency hedged equity strategy wrapped in an ETF may be an efficient way for UK investors to isolate the potential positive returns in equity markets from the potential negative returns in FX markets.

Chart 1

Chart 1 shows the since inception performance of the WisdomTree’s Germany Equity UCITS ETF – GBP Hedged total return index in GBP, together with the EUR/GBP spot rate as well as vs the DAX 30 (expressed in EUR and GBP terms).

Over the period shown, UK investors would have incurred a significant currency risk when buying into German equities at a time when the euro was depreciating relative to the pound. In fact, the euro depreciated 7.4% this year relative to the pound, having weakened by 15% since the inception of the index (30 April 2014). This implies that while the DAX is up 18% this year and up 2.6% in 2014 in euro terms, it would be up only 10.1% this year and down 3.9% in 2014 when converted into GBP. However, when investing in an export biased basket of German stocks that is also currency hedged, UK investors are given the opportunity to efficiently take advantage of that segment of the German equity market that is likely to be most sensitive to currency fluctuations.

In the face of QE in the Eurozone, whereby the ECB is now also looking to accelerate the asset purchases ahead of a low-liquidity summer period, the pressure that the program may put on the euro could be another boost to the top (and bottom) line projections of German exporter stocks, and potentially provide more support for their stock prices. Over time, the extra performance reaped by neutralising the depreciating effects of QE- induced inflationary expectations on the currency that are detrimental to the in GBP converted performance for UK investors exposed to German exporter stock basket can be substantial. As shown in the chart, the performance gap between the hedged vs the unhedged exposure to the German equity market has grown considerably on the back of QE. However, an export tilted German stock portfolio where the GBP/EUR FX risk is hedged, UK investors may reap the benefit of generating German equity market like returns in sterling. The index of the WisdomTree’s Germany equity UCITS ETF that is GBP hedged has been able to closely follow the performance of the DAX 30. Hence, UK investors are able to get DAX 30 equivalent returns in one simple trade ETF.

Chart 2

In spite of the substantial depreciation of the euro relative to the pound in recent years, the risks of the euro devaluing further should not be ignored. QE is expected to last until 2016, which until it is unwound will keep the lid on Eurozone’s suppressed bond yields that, in the face the uncertainty overhanging Greece’s future in the Eurozone, makes the Eurozone by and large an unattractive investment destination for investors seeking competitive income yield. In particular when compared to the UK, where improved growth expectations have widened UK’s long term interest rate differential with Germany to well over 100 bps, as shown in chart 2 (previous page). The risk of depreciation and considerably volatility to which the euro-pound exchange rate could become subject may be a prudent reason to hedge currency risk. Not leaset because when gauged by the strong performance of Germany's equity market, the currency hedge may well be worth it.

Investors sharing this sentiment may consider the following UCITS ETF:

 All data is sourced from WisdomTree Europe and Bloomberg, unless otherwise stated.

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WisdomTree Europe Ltd is an appointed representative of Mirabella Financial Services LLP which is authorised and regulated by the Financial Conduct Authority. The value of an investment in ETPs may go down as well as up and past performance is not a reliable indicator of future performance. An investment in ETPs is dependent on the performance of the underlying index, less costs, but it is not expected to match that performance precisely. ETPs involve numerous risks including among others, general market risks relating to the relevant underlying index, credit risks on the provider of index swaps utilised in the ETP, exchange rate risks, interest rate risks, inflationary risks, liquidity risks and legal and regulatory risks. ETPs offering daily leveraged or daily short exposures (“Leveraged ETPs”) are products which feature specific risks that prospective investors should understand before investing in them. Higher volatility of the underlying indices and holding periods longer than a day may have an adverse impact on the performance of Leveraged ETPs.  As such, Leveraged ETPs are intended for financially sophisticated investors who wish to take a short term view on the underlying indices. As a consequence, WisdomTree Europe Ltd is not promoting or marketing BOOST ETPs to Retail Clients. Investors should refer to the section entitled "Risk Factors" and “Economic Overview of the ETP Securities” in the Prospectus for further details of these and other risks associated with an investment in Leveraged ETPs and consult their financial advisors as needed.  Within the United Kingdom, this document is only made available to professional clients and eligible counterparties as defined by the FCA. Under no circumstances should this document be forwarded to anyone in the United Kingdom who is not a professional client or eligible counterparty as defined by the FCA. This marketing information is intended for professional clients & sophisticated investors (as defined in the glossary of the FCA Handbook) only. This marketing information is derived from information generally available to the public from sources believed to be reliable although WisdomTree Europe Ltd does not warrant the accuracy or completeness of such information. All registered trademarks referred to herein have been licensed for use. None of the products discussed above are sponsored, endorsed, sold or promoted by any registered trademark owner and such owners make no representation or warranty regarding the advisability on dealing in any of the ETPs.
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