(Bloomberg) -- The world's biggest money managers are staking a claim in the surging market for stock and bond ETFs that strip out currency risk.
Industry giants BlackRock and State Street are rolling out hedged ETFs at an unprecedented clip after smaller rivals lured the bulk of $41 billion of inflows this year. BlackRock started 11 of the funds this month, including ETFs protecting against moves in the Australian dollar and Mexican peso, while State Street opened a euro-focused version in June. Sitting out the year's most popular strategy isn't an option for fund companies, which are increasingly reliant on exchange-traded products to generate income.
The number of currency-hedged ETFs listed in the U.S. has doubled during the past year to 60, with at least 30 more registered with regulators, according to data compiled by Bloomberg.
"It's been fast and furious with issuance," says Kevin Kelly, the New York-based chief investment officer at Recon Capital Partners, which manages more than $300 million and has bought funds focused on Germany. "Some of the newer products are going to have a tough time, especially if they're levered, especially if they just cover a broad index that is already out there from another issuer."
The companies are tapping into growing demand from U.S. retail investors who've sought exposure to international stocks and bonds but want to avoid exchange-rate fluctuations.
WisdomTree Investments's Europe Hedged Equity Fund has added $14.5 billion this year, more than any other ETF in the world, while returning 17%. Deutsche Asset & Wealth Management's hedged ETF focusing on developed economies in Europe and Asia has attracted $10.9 billion.
The products have gained traction as monetary policy in the U.S. diverges from the rest of the world, boosting the greenback to multiyear highs and imperiling international returns for American clients when translated back to dollars.
Clients "are looking for more options to help them manage their currency risks, which is why we added more single countries, regions and small cap," says Jane Leung, the San Francisco-based head of precision exposures at iShares, BlackRock's ETF unit.
(BlackRock said second-quarter profit rose 1.4% as it attracted money into higher-fee products including active funds and exchange-traded funds.)
Investors pulled $7.3 billion from BlackRock's funds in the quarter, but iShares ETFs attracted almost $10.9 billion and its retail products added another $10.8 billion, as investors pulled $31.4 billion from institutional index offerings.
Together, ETFs and passively managed funds will take in about 35% of flows into investment products from 2015 to 2018, up from 14% last year, according to Boston Consulting Group.
That's prompting a race to the bottom on fees as entrants look to attract investors from more established peers. State Street, Invesco's PowerShares and ProShare Advisors all recently started their first hedged funds charging about half the market average, which is about 0.5%, Bloomberg data show.
"We have to compete," says Steve Cohen, head of strategy at ProShare Advisors in Bethesda, Ma. "Maybe in this particular case it's going to put less into the bottom line but we're OK on that."
Other providers are getting creative with their focus or structure. In June, Direxion Investments started the first leveraged currency-protected ETFs to amplify returns. Funds sometimes use swaps or derivatives to accomplish that.
"Since we're employing leverage to these benchmarks that's definitely a differentiator," says Edward Egilinsky, the New York- based head of alternative investments at Direxion, which offers European and Japan funds.
Trouble is, all these products may be a little late to the party. Flows are slowing, with investors channeling $2.77 billion into them last month, the least since December.
"We're less concerned about the short term," says Nick Good, Boston-based chief operating officer of the U.S. intermediary business at State Street. "There obviously has been a burst of demand and that won't continue indefinitely, but we do see long-term demand for hedged as well as unhedged versions of key ETFs."
While the dollar is forecast to gain versus 13 of its 16 major peers by year-end, its advance is decelerating. The greenback is predicted to strengthen about 5% versus the euro by Dec. 31, after rallying about 23% over the last 12 months.
That has some existing and wannabe providers of hedged ETFs taking a different tack: pitching investors looking to cautiously return to unhedged investments.
New York Life is planning five 50%-hedged funds through its Index-IQ unit, while BlackRock is marketing a strategy that rotates between hedged and unhedged products. "You can actually easily flow back and forth," says Leung at iShares. "Volatilities and correlations change rapidly. You do have to be aware if you're using this as a tactical play to be monitoring those movements and adjusting your ratio accordingly."