Deutsche Bank has another problem: Its ETF business

Deutsche Bank - Foyer Bridge

A change in the currency trade winds this year has taken a tough toll on Deutsche Bank as it fights to dispel worries about its overall stability.

As if Deutsche Bank officials don't have enough to worry about this year, they also have to contend with money bleeding out of their exchange-traded products.

The burgeoning $2.4 trillion ETF industry has been kind to a lot of big players on Wall Street, with Deutsche Bank being a significant provider of the products. However, a change in the currency trade winds this year has taken a tough toll on a bank fighting to dispel worries about its overall stability.

Thus far in 2016, Deutsche's fairly expansive ETF family has seen nearly $6.7 billion in outflows, representing roughly a one-third decline in assets. The bank has moved down a notch, from 10th to 11th, among leading ETF providers, with $13.3 billion in assets currently, according to FactSet.

Exacting most of the damage has been an unwind of one of 2015's hottest trades — currency hedging, with the expectation that the U.S. dollar was on a steady trek higher and European economic growth would pick up. With the Fed on hold and euro zone economies struggling, the currency hedge trade — ETFs that had seen sharp inflows on its expectations — has come undone.

"The challenge for them has nothing to do with the bank itself and more to with their assets are primarily focused on their international equity products," said Todd Rosenbluth, director of ETF and mutual fund research at CFRA. "Investors have been moving money out of those products in 2016, with concerns about economic prospects in Europe, concerns about Japan, and adding on to it the dollar has not done what it did last year."

The biggest hit by far to the Deutsche products has been its Deutsche X-trackers MSCI EAFE Hedged Equity ETF, the $7.8 billion fund has lost nearly 40 percent of its assets this year though it is only down 2 percent in price. The fund carries exposure to developed global stock markets while hedging against fluctuations in the dollar. Other funds have taken hits as well (see chart).

"Despite outflows, we continue to believe we are in the environment when currency hedging delivers value over unhedged strategies," Deutsche said in a statement. "Currencies continue to add considerable volatility to performance, and our outlook is for the U.S. dollar to strengthen against the foreign currencies. This paired with positive carry in many markets, makes currency hedging a strong proposition."

Deutsche said it believes the move against currency hedges is cyclical, and pointed out that its market share in currency hedged products actually has increased from 31 percent to 34 percent this year.

It's been a rough year overall for currency products, which have seen nearly $455 million in outfliows, about a 13 percent decline. Fixed income has seen the biggest gain in total inflows at $80.2 billion, while equity products have pulled in $60.9 billion, according to FactSet.

"For hedge products to have success, investors need to buy into the theme that they're reducing risk," Rosenbluth said. "If and when the dollar strengthens again, the trade will return to popularity."

BlackRock remains the largest provider of ETF products, with $938.3 billion under management. Vanguard is next with $576.5 billion, while SSGA follows with $454.6 billion.

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