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ETF Specialist

To Hedge or Not to Hedge?

There are important trade-offs to consider when taking the foreign-currency exposure out of your international-equity ETF.

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This is an updated version of an ETF Specialist originally published on Feb. 19, 2014.

Currency-hedged exchange-traded funds have come into vogue of late in the United States. Investor interest was first piqued by the performance of the oldest and largest of them all: WisdomTree Japan Hedged Equity (DXJ). The fund owns a portfolio of dividend-paying Japanese stocks that generate more than 80% of their revenue outside of Japan. It gained nearly 42% in 2013, as a massive dose of monetary stimulus contributed to an 18% decline in the value of the Japanese yen, and steady improvement in the global economy gave Japan's stock market an additional boost. In contrast, iShares MSCI Japan ETF (EWJ), which tracks a standard market-cap-weighted benchmark and does not hedge its yen exposure, increased by 26% in 2013. Clearly, it paid for U.S. investors in Japanese stocks to have a hedge against a declining yen over this span. But was this a flash in the pan, or do currency hedges have value over longer time frames? With the U.S. dollar marching steadily higher--thanks in part to (relatively) attractive interest rates--and double-digit moves in major currencies making headlines, now is a good time for investors to explore these questions.

Ben Johnson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.