Against the backdrop of ECB quantitative easing, last week sterling sat at a seven-year high against the euro, which also fell to a 12-year low against the dollar.
Investing in hedged share classes has long been an option for investors in European funds, though that’s not to say that there has been a wide choice of products available.
“Historically, fund pickers have not really been worried about currency hedging but that has changed in the past two years as it has become more apparent that the world has entered an under the radar currency war,” says Ryan Hughes, fund manager at Apollo Multi Asset Management.
Total mismatch
“The world has ended up in a position where currency cycles are in a total mismatch and the funds industry has only recently realised this is where they have been behind the curve in terms of product development – very few groups have offered European equity funds which are hedged.
“There is a definite element of catch-up that groups need to do in terms of offering hedged share classes across their book of business and from what I have heard that is on top of fund companies product development task lists, and they want to launch these products very quickly.”
Still, according to Morningstar data, flows into currency hedged European equity funds have increased rapidly in recent years, even before this year’s movements. In December 2012, total net assets in these funds totalled €586m, while by the end of this year the figure was €8.2bn.
One group that has offered hedged share classes for some time, on its European Enhanced Income and Absolute Return funds, is Argonaut. The company reports that demand for these funds has grown rapidly over the past five months, and it is in the process of preparing another a hedged share class for its European Alpha Fund.
“Argonaut Income fund remains fully unhedged, while the Argonaut Enhanced Income Fund is as fully hedged back to sterling as we can sensibly make it,” founding partner and co-manager Olly Russ said last month.
“Over the last year or so, when forced to express a preference, we have been gently steering clients in the direction of the Enhanced Fund versus the main fund, not on the basis of the covered call overlay, which adds relatively little at the moment in these times of low volatility, but due to the currency hedge.
Hidden source of strength
“Now Europe has announced QE, to some extent there is a travel and arrive story. Nonetheless, as a sub-optimal currency union without a single finance minister, the euro is unlikely to discover a hidden source of strength imminently.”
Only a handful of UK open-ended funds investing in Europe currently offer hedged share classes to retail investors. Another that does is JPM Europe Dynamic ex UK Fund.
JPMorgan reports that in all of 2014, only about 20% of the gross flows into this particular fund went into the hedged share class. In the first month of 2015, that jumped to 73% of inflows.
Looking at the percentage of the hedged share class AUM relative to total fund AUM at the end of February 2014, it made up only 13.2% of the total fund. This compares to 32.8% currently.
But, as a wealth manager what if your preferred fund/strategy is not available as a hedged version? Hughes hedges his euro exposure to dollars using a rolling three-month forward FX trade. Elsewhere, the likes of F&C’s Multi-Manager team and discretionary Rowan Dartington use ETFs.
For example, the latter uses ETF Securities’ ETFS 3x Long EUR Short USD, as investment director Tim Cockerill explains: “We can have both the European equities fund we really want and the hedging. For example, if we have 6% in a fund then, because it is three times leveraged, we’ll need 2% in the ETF, though I am conscious of taking up our share of allocation with hedging.
“However, at this moment I am weary of hedging the euro because, after the recent QE shock, I am not sure there really is going to be another big leg to the currency drop. It will find a floor.”
