The Flawed Logic of HEDJ: Why Currency-Hedged ETFs Struggle in a Weak Dollar Environment

In 2025, the U.S. dollar has experienced its most significant decline in over 50 years, losing more than 10% of its value against major currenciesHEDJ: Not The Right Way To Play A Weaker Dollar^[1]. This dramatic shift has reshaped global investment dynamics, particularly for currency-hedged exchange-traded funds (ETFs) like the WisdomTree Europe Hedged Equity Fund ETF (HEDJ). Despite its design to mitigate currency risk, HEDJ has underperformed its unhedged counterparts, exposing critical flaws in its hedging strategy amid a weak dollar environment.

The Mechanics of HEDJ and Its Intended Purpose

HEDJ aims to provide exposure to European equities while hedging out euro/dollar currency risk. By using derivatives such as futures and forward contracts, the fund seeks to neutralize the impact of exchange rate fluctuations[iShares Currency Hedged MSCI Emerging Markets ETF]^[6]. This approach theoretically benefits U.S. investors by isolating them from the volatility of the euro, a strategy that historically proved effective during periods of dollar strength. For instance, over the decade ending June 2025, the MSCI EAFE Currency Hedged Index outperformed its unhedged counterpart by approximately 2.5% annually, driven by favorable interest rate differentials and a strong USDBlog | Currency Hedging: how has it worked and how might it work …^[2].

However, the 2025 dollar slump has turned this logic on its head. As the greenback weakened, non-U.S. assets—including European equities—became more attractive to U.S. investors. The euro's appreciation against the dollar amplified returns for unhedged European equities, as gains in local currencies translated to higher dollar-denominated profitsWhere is the U.S. dollar headed in 2025? | J.P.^[5]. HEDJ, by contrast, locked in a fixed exchange rate, effectively capping the upside potential that investors could have realized from the euro's rally.

Why HEDJ Fails in a Weak Dollar Scenario

The underperformance of HEDJ stems from three key factors:

1. Cost of Hedging: Currency hedging is not free. The cost of forward contracts and other derivatives eats into returns, particularly in a low-interest-rate environment. In 2025, as the dollar weakened, the cost of hedging became a drag on performance. For every percentage point the euro gained against the dollar, HEDJ's hedging strategy offset roughly 0.8% of potential returnsHEDJ: Not The Right Way To Play A Weaker Dollar^[1].

2. Mismatched Timing: HEDJ's hedging strategy was optimized for a strong dollar era. The MSCI EAFE Currency Hedged Index's historical outperformance (2.5% annually) relied on a USD that was appreciating against other currenciesBlog | Currency Hedging: how has it worked and how might it work …^[2]. In 2025, however, the dollar's decline has rendered this strategy counterproductive. Investors who hedged out currency exposure missed out on the euro's gains, which became a tailwind for European equities.

3. Structural Limitations: HEDJ's focus on hedging only euro/dollar exposure leaves it vulnerable to other currency fluctuations. For example, the fund does not hedge against the British pound or Swiss franc, which also strengthened against the dollar in 2025HEDJ: Not The Right Way To Play A Weaker Dollar^[1]. This partial hedging approach creates an uneven risk profile, undermining the fund's core objective of comprehensive currency risk mitigation.

Broader Market Dynamics and Investor Implications

The 2025 dollar crisis has forced a reevaluation of hedging strategies. Central banks, including those in Europe, have accelerated efforts to diversify away from the U.S. dollar, further pressuring the greenbackThe Decline of the Dollar in 2025 | Mercer Advisors^[4]. Meanwhile, U.S. investors are increasingly recognizing that a weaker dollar can act as a “hidden dividend” for non-U.S. stocks. For example, European equities gained 12% in dollar terms in 2025, with roughly 4% of that return attributable to currency movements aloneThe 2025 US dollar crisis: why investors are …^[3]. HEDJ's failure to capitalize on this dynamic highlights a broader issue: hedging strategies that worked in a strong dollar environment may now be liabilities in a weak one.

Conclusion

HEDJ's underperformance in 2025 underscores the importance of aligning hedging strategies with macroeconomic conditions. While currency hedging can reduce volatility in a strong dollar environment, it becomes a drag when the dollar weakens. Investors seeking to capitalize on the current climate may find greater value in unhedged ETFs or selectively hedged strategies that preserve exposure to favorable currency movements. As the dollar's trajectory remains uncertain, the lessons from HEDJ's struggles will likely prompt a rethinking of hedging approaches across global markets.