Sorry, But You Can't Trade Germany Risk-Free

Is a popular currency-hedged trade on Germany too good to be true?

by Adam Warner

Published on Jun 2, 2015 at 8:52 AM
Updated on Jun 2, 2015 at 8:52 AM

If you’re looking for a contra tell on the euro and/or euro volatility, I bring you this nugget, uncovered by Bloomberg:

"U.S. traders are shunning a traditional exchange-traded fund tracking German shares, pouring money instead into one that protects against euro swings.

"The iShares Currency Hedged MSCI Germany ETF received $135 million in May, while the non-hedged version had its first monthly withdrawals of the year. Investors opted to shield their equity returns as the dollar strengthened against the euro amid speculation about a rate hike from the Federal Reserve.

"With moves in the currency becoming the main element affecting the DAX Index, hedging has become a key component of investors’ strategies. The German ETF with built-in protection climbed in May, while the other one had its worst month of 2015. And analysts are predicting the European Central Bank’s asset-buying program will help push the euro down another 5 percent at least through March of next year."

Translation: Investors want to buy Germany; they just don’t want gains wiped away via currency depreciation. So, enter an ETF that does just that.

It's not difficult to see why this has become a popular idea. Europe is QE-ing. We’re ostensibly tightening someday. Ergo, money should flow to our high-yielding (OK, trending-up-from-zero-someday-yielding) currency.

But that same European QE should boost stocks overseas. So why do I think this is all flawed?

Well, it's not, of course. We’ve all taken (or at least heard of) entry-level economics. These are dynamics we learned about. I simply think it's flawed because this is all entirely known. Who’s left out there to put on any variation of this play? There’s literally a TV feature every day where two guests discuss the timing of the next potential Fed tightening. I’m pretty sure anyone running serious money has allocated with all of this in mind.

I see it more as something akin to the yen carry trade. It's logical economically, but incredibly crowded and subject to massive, random dislocations. There’s all sorts of ways the masses could get scared out of this German play: Europe slows down their QE; we slow down our tightening; Greek pops its head up; Germany’s growth slows down; FIFA demonstrates there was no corruption in their awarding of World Cup venues, et. al.

Quite simply, if either German stocks do poorly or the currency does well, this now-popular ETF becomes a terrible play. I’m just very wary of something that seems so obvious.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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