February 10, 2013

Commodities and Currencies: Two ETF Trends to Watch in 2013

Investors should hedge against inflation risk and currency devaluation in Japan, Deutsche Bank’s Kremenstein warns

While it’s impossible to know what the future holds, it is possible to surmise what large numbers of investors think the future holds.

Martin KremensteinAnd from the perspective of Martin Kremenstein (left), who oversees Deutsche Bank’s $12 billion ETF portfolio in the U.S., investors are seeking portfolio diversification and expressing concern over inflation risk through a significant and growing allocation to commodities.

Speaking with AdvisorOne ahead of this year’s InsideETFs conference, which kicks off Sunday in Hallandale Beach, Fla., the Deutsche Bank executive has a unique vantage point, since he oversees the market’s largest broad-based commodities ETF.

And what he sees is a fund that is swelling with investment at an accelerating rate. The PowerShares DB Commodity Index Tracking Fund (DBC), with about $6.5 billion in assets, raised $1 billion in net new assets last year, at more than twice 2012’s combustive pace, adding another $200 million in January.

Calling DBC a bellwether for investor sentiment on commodities, Kremenstein says investors are adding exposure to the asset class primarily for two reasons.

“Sometimes they are using it as a hedge against inflation and other times as a diversifier to smooth out portfolio returns," he says. "It’s never a bad time to use as a diversifier.” 

Fears of inflation have risen to higher proportions recently, he adds.

“People are more worried about inflation than they have been in a while. The shooting up of ag prices late last year has gotten many people worried about food and energy inflation.”

As to portfolio diversification, he says “people have been underallocated [to commodities] for some time.”

The other key trend Kremenstein sees investors preparing for in 2013 is a strengthening dollar.

“The currency exposure that investors are running from their foreign investments, they’ve never paid any attention to,” the Deutsche Bank executive says. “They tend to only starting to examine it when it starts to go against them,” a lesson the election of Japan’s new prime minister is currently teaching investors.

A proponent of aggressive monetary easing, Prime Minister Shinzo Abe campaigned on a platform of weakening the yen as a means of boosting the moribund Japanese economy. Anticipating his victory in December, Japanese equities began soaring in November.

But Kremenstein notes that not all investors in Japanese equities have performed equally well. Investors in an unhedged ETF like the iShares MSCI Japan Index (EWJ) have been handsomely rewarded with a 9% return in just three months.

But investors with portfolios hedged against currency fluctuations, such as Deutsche Bank’s MSCI Japan Currency-Hedged Equity Fund (DBJP), have seen their Japan investments soar 28% in the same time.

“Being long Japan without taking currency risk is really topical for advisors. The devaluation of the yen is a continuing theme if you want exposure to Japanese equities,” Kremenstein says, citing historical data on the yen’s value.

“Look at the yen versus the U.S. dollar. It’s been much weaker in the past. As recently as 2008, the yen was at 110; now it’s at 93. If you go back to 2002, it was 134. At its strongest it was at 75 or 76. So it’s still much closer to the high point than to its low.”

In other words, since the yen remains relatively highly valued and since the government has pledged further weakening of its currency, investors have grounds to take them at their word.

“The more they try to devalue the yen, Japanese equities should re-price to take account of that devaluation,” Kremenstein explains.

“If you value something in yen, as the yen gets less valuable, then the price in yen is going to go up. All in all, it should be better for the economy and better for the equity market.”

Kremenstein points to Brazil as another major market whose leadership appears to be gearing up to weaken its currency, the real.

Such a move would benefit investors in Brazilian stocks, particularly if their investments are hedged against the effects of currency fluctuations.

A strengthening dollar could blunt or overwhelm an unhedged U.S.-based investor’s gains in a rising foreign equity market; dollar bears, however, may want to remain unhedged.

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Check out AdvisorOne’s InsideETFs 2013 enhanced landing page for complete conference coverage.

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