As South Korean investors shift the focus of their exchange-traded fund (ETF) holdings from domestic to U.S. markets, whether a fund hedges its currency exposure is dividing returns. With the won strengthening rapidly against the dollar — pushing the exchange rate below 1,400 won per dollar — unhedged products, from U.S. stocks to long-term bonds, have uniformly trailed their currency-hedged counterparts.
The TIGER US S&P500 posted a one-month return of -3.91%, according to the Korea Exchange on the 21st. By contrast, the TIGER US S&P500 (H), which tracks the same S&P 500 index while hedging against exchange-rate swings, rose 2.19%, leaving a 6.10 percentage-point gap between the two products. The RISE US Semiconductor NYSE fell 5.23% over the past month, while its hedged version, the RISE US Semiconductor NYSE (H), managed to hold a positive return of 0.38%.
The recent decline in the won-dollar exchange rate is seen as eroding the won-denominated performance of overseas assets. For unhedged overseas ETFs, won-based returns reflect not only the price of dollar-denominated assets but also currency movements. When the won gains value, the won-converted value of dollar assets held falls. Hedged products, which lock in the exchange rate in advance using currency futures and other tools to minimize the impact of volatility, offset this effect and delivered better performance.
The exchange rate also divided losses in bond products, not just equities, as fixed-income instruments took a direct hit during a period of rising rates. The ACE US 30-Year Treasury Active recorded a one-month return of -8.49%. The yield on U.S. 30-year Treasury bonds spiked to the 5.33% range in intraday trading on the 18th — the highest level in 19 years — and the added burden of currency losses compounded the damage. By contrast, the ACE US 30-Year Treasury Active (H), stripped of exchange-rate effects, saw a return of just -2.39% over the same period.
The won-dollar exchange rate fell below 1,400 won for the first time in about 10 months, then dropped further to the low 1,380-won range on the same day. Through last month, domestic supply and demand — dollar selling by exporters and coordinated policy support — led the decline, but this month, shifting expectations over U.S. monetary policy have underpinned the won's strength. Weaker U.S. employment and consumption, along with easing price pressures, have dimmed prospects for further rate hikes by the Federal Reserve, and some positions built on assumptions of rising rates and a stronger dollar have been partially unwound.
"If downward pressure on long-term rates eases due to weakening economic indicators and U.S. Treasury buybacks, the pressure for a stronger dollar could weaken further," said Choi Kyu-ho, a researcher at Hanwha Investment & Securities. "Volatility could widen depending on short-term issues, but for the time being, the exchange rate should center around the high 1,300-won to low 1,400-won range."
