When a fad falters

Investors are now seeing the downside of one of last year’s hottest trends.

Billions of dollars flowed into a niche of fund investing last year after U.S. investors felt they weren’t getting the full effect of a jump in European stocks. That’s because the value of the euro was falling at the same time, which meant that dollar-based returns were getting diluted. The MSCI Europe index jumped nearly 16 percent in euros during last year’s first quarter, for example. After translating that into dollars, the gain was less than 3 percent.

Enter “currency-hedged” funds, which try to cancel out the effect of changes in currency values. The WisdomTree Europe Hedged Equity ETF, for example, jumped nearly 19 percent in last year’s first quarter.

Now, though, the dollar’s rally has stalled. Its value has dropped or stayed roughly flat with the euro, Japanese yen and several other currencies, which reduces the advantage for currency-hedged funds. And if the euro begins rising sharply, currency-hedged funds will start lagging behind traditional investments.

The MSCI Europe has dropped 6.4 percent this year in euro terms through Monday, and has lost 5.5 percent in dollar terms. The WisdomTree Europe Hedged Equity ETF is down 2.6 percent. Investors pulled a net $1.5 billion from the fund in June alone, according to Morningstar. Other currency-hedged ETFs have also seen big withdrawals recently.

“It looks like investors are deciding that hedging is no longer worth it,” Morningstar senior analyst Alina Lamy wrote in a recent report.