Yen-Hedged ETF Suffers Exodus of Cash From Carry-Trade Fiasco

(Bloomberg) -- Investors spooked by the yen carry-trade blowup have pulled cash from a Japan-focused stock ETF that strips out moves in the country’s currency. 

The WisdomTree Japan Hedged Equity Fund (ticker DXJ) saw an outflow of more than $400 million last week, the most since 2018, data compiled by Bloomberg show. At the same time, short interest as a percentage of shares outstanding on the ETF rose to the highest since May, according to data from IHS Markit Ltd. 

The fund, which invests in Japanese stocks while hedging against weakness in the yen, had been rallying all year, benefitting from rock-bottom interest rates in the country. But all of that was upended in recent days when the Bank of Japan shocked markets with an unexpected rate hike, which led to an appreciation in the yen versus most major currencies and a plunge in Japanese equities. That proved painful for investors who had borrowed money in the Japanese currency and used it to fund purchases of higher-yielding assets elsewhere, something known as the carry trade. 

“A combination of the huge Japan equity market decline — that’s selling pressure there. Plus, if the yen continues to strengthen, that makes DXJ less appealing since hedging isn’t needed as much,” said Todd Sohn, an ETF strategist at Strategas. 

The Bank of Japan at the end of July hiked its benchmark interest rate and unveiled plans to halve bond purchases, causing the yen to strengthen. Only about a third of BOJ watchers had been predicting a raise as their base-case scenario. But it showed the central bank’s determination to proceed with normalization of their policy after years of ultra-easiness. 

The amount of money involved in the carry trade is disputed — estimates range from tens of billions of dollars into the trillions. Amid all the turbulence, DXJ has lost 10% since the end of July. The fund’s cash withdrawal last week now puts it on pace for its worst month of outflows since December 2018, though it still has a positive haul overall for the year. 

“The impact is simply based on the fact that a stronger JPY is bad for Japanese equities — it impacts earnings and potential market share,” said Mark McCormick, global head of FX and EM strategy at TD Securities. “Moreover, positioning and flows likely exaggerate the move as Japanese equities were outperforming for quite some time, likely reflecting the policy settings in Japan: soft JPY, low real rates and no real response to elevated inflation.” 

--With assistance from Kristine Aquino.

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