have been in the spotlight lately, but there are other plays
available outside of the Land of the Rising Sun.
The iShares MSCI EAFE ETF (NYSEArca:EFA) has long been the go-to
play for exposure to the developed ex-U.S. market.
Unfortunately, most investors forget about the inherent currency
exposure involved in owning EFA and other international funds. But
in June 2011, Deutsche Bank launched the perfect complement to
EFA-the db X-trackers MSCI EAFE Hedged Equity Fund
(NYSEArca:DBEF)-and it's starting to show its true colors.
First, let's review how currency exposure works.
Because EFA holds international stocks, its fund managers must
exchange U.S. dollars for foreign currency before buying the ETF's
portfolio. When the net asset value of EFA is calculated at the end
of the day, however, the fund's custodian must convert the value of
those stocks back into dollars.
That means there's an additional variable at play in the ETF's
value:If the foreign currency appreciates against the dollar,
investors will see a greater return than just the pure equity
performance. Conversely, when the foreign currency depreciates
relative to the dollar, the return erodes.
While DBEF provides the exact same exposure as EFA-it tracks the
same index, after all-it also hedges out the foreign currency
When compared against DBEF since its June 2011 inception,
there's no doubt that the pound, yen and euro have taken their toll
on EFA-the fund gained only 4.5 percent, while DBEF climbed 14.91
percent in the same period.
Even if you don't have an opinion on currency movements, the
prudent strategy is to maintain a 50/50 exposure to EFA and DBEF.
That way, you can maintain neutral exposure to the underlying
So why have most investors "slept on" DBEF? Quite simply, it's
because of liquidity.
DBEF only trades an average of 10,000 shares per day, and
bid/ask spreads have been fairly sporadic, reaching as much as 0.69
percent, or nearly double the fund's expense ratio of 0.35
That may not be an issue for large orders, of course. But
investors buying smaller blocks would be best served by reaching
out directly to the ETF issuer's capital markets desk; in this
case, Deutsche Bank.
The capital markets desk would be more than willing to help
facilitate your trade in order to ensure you can get in and out of
the fund at fair prices by using Deutsche Bank's own network of
What I'm saying is this:No matter how you approach it, it pays
to keep on top of currency exposure in your portfolio, and ruling
out currency hedge strategies based on liquidity could cost
At the time this article was written, the author had no
positions in the securities mentioned. Contact Ugo Egbunike at
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