Fighting the Last War

“It has been said critically that there is a tendency in many armies to spend the peace time studying how to fight the last war.” – J.L. Schley, Lieutenant Colonel, 1929

There are many parallels between military strategy and investing strategy. Markets, like wars, are unpredictable and investors much like generals must be prepared for a wide spectrum of outcomes. That preparation can take on one of two forms: focusing on the past (fighting the last war) or anticipating the future (fighting the next war).

With the advent of ETFs, fighting the last war has never been easier. Products can be launched at the drop of a hat to meet investor demand that is inexorably tied to recent performance.

Two weeks ago, I wrote about volatility ETFs that were launched after the 2008 crisis, fighting the last war at the time which was volatility.

Today I want to revisit a topic I wrote about in March of 2015 when currency hedging was all the rage (see “The Currency Hedging Boom”).

At the time, the Dollar Index had just advanced 25% over 9 consecutive months, its longest streak in history dating back to 1967.


The story behind the move was simple: a U.S. Federal Reserve that was gearing up to hike rates against the rest of the developed world (Europe and Japan in particular) that was still easing.

By the end of March 2015, over $18 billion had flowed into currency hedged equity ETFs, chasing the strong returns from what was essentially a short bet on the Euro and the Yen.


Fast forward to today and what do we observe? 2 out of the 3 largest ETF outflows this year are in – you guessed it – currency hedged ETFs.


Why are “investors” running for the exits? Two words: past performance. You see, these so-called investors need to be in “what’s working” at all times, and these ETFs no longer fit into that category.

Currency hedged Japan (DXJ) is down 22% versus a decline of 9% for the unhedged version (EWJ) while currency hedged Europe (HEDJ) is down 16% versus 8% for the unhedged version (VGK). Instead of adding to returns, currency hedging detracted.


How did this happen? Well, the seemingly unthinkable occurred. The Euro and Yen traded higher versus the U.S. Dollar since last March even though the Fed hiked rates last December while the ECB and the BOJ both cut rates into negative territory.

Where are those “investors” who chased currency-hedged ETFs higher last year going? I don’t know, but if I had to guess they’re likely booking the loss to fight the next war, chasing the latest fad.


Currency Hedging vs. Currency Chasing

In the end, the story here was never actually about currency hedging; it was all about currency chasing. There is perhaps a case to be made for long-term U.S. dollar investors to hedge out foreign currency risk, but the case only holds if investors actually stick with the hedge through good times and bad. As we know, though, most investors are not wired to hold anything through bad times. Therefore, attempting to hedge out currency risk ends up doing more harm than good.

Why? Because there is only real demand and urgency to hedge when hedging has already “worked,” meaning after the fact. This would be fine if the next war looked exactly like the last one, but as we know it rarely does.

Instead of wasting time fretting about the last war, then, investors should be preparing for the next one. In investing, that means avoiding the latest fads, sticking with an investment plan/strategy, and maintaining a diversified portfolio that can withstand multiple outcomes.

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The Currency Hedging Boom

The Black Swan Siren Song

Chasing Momentum

Anomalies, Cycles, and Inevitable Periods of Underperformance

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.



Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors previously held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.


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