A week before the leaders of the Group of 20 economies were scheduled to meet in Toronto, China’s central bank announced that it will embrace policies that the international community has been promoting for years. In a somewhat unexpected development, Beijing stated its intention to make its exchange rate more flexible on Saturday night, ending a long period of speculation that occasionally saw foreign officials publicly criticize China’s currency policies.
The development will quickly ripple through the global economy. The most obvious result will be an appreciation of the yuan relative to the U.S. dollar, although the magnitude and timing of such a rise is still uncertain. Economists predict that the move will also increase the spending power of Chinese consumers, helping to transition China’s economy from an export-driven model to one more dependent on local consumption. “China is now speeding up the restructuring of the economy and transforming its growth model, a task that has been made even more important and urgent by the international financial crisis,” said the central bank in a statement.
The decision drew fierce protests from industries that enjoy strong overseas demand from their products, since a rising yuan will make goods more expensive to international consumers. But the end of the two-year old peg received unanimous praise from markets around the world, and is expected to benefit the Chinese economy over the long run. “Both China’s trading partners and the country’s own leaders say such a shift would be good for China and the rest of the world,” writes Andrew Batson. “It would make China less vulnerable to external troubles, while also reducing the politically troublesome trade surplus and providing more opportunities for international companies in the Chinese market.”
Yuan ETFs On The Move
The news out of Beijing over the weekend is likely to cause a surge in interest in ETFs that offer exposure to the yuan/dollar exchange rate. At the beginning of the year, currency derivatives markets had been pricing in about a 3% increase in the value of the yuan relative to the dollar over the next 12 months. But criticisms from foreign officials strengthened the resolve of Chinese officials wary of appearing to give in to pressures from the West; expectations for yuan appreciation had recently declined to about 1%, a trend reflected in the charts below.
Although any immediate appreciation is expected to be moderate, the appeal of establishing exposure to the Chinese currency has increased significantly. Currently, there are two ETFs offering pure play exposure to the Chinese yuan, although the differences between these funds are both numerous and potentially significant.
- WidsomTree Dreyfus Chinese Yuan Fund (CYB): This actively-managed ETF seeks to achieve total returns reflective of both money market rates in China available to foreign investors and changes in value of the Chinese Yuan relative to the U.S. dollar. CYB has been one of the most popular ETFs of 2010, taking in more than $350 million in cash inflows through the first five months of the year.
- Market Vectors Chinese Renminbi/USD ETN (CNY): This ETN is a senior, unsecured debt security issued by Morgan Stanley that is linked to the S&P Chinese Renminbi Total Return Index. That benchmark consists of currency forward contracts plus short-term deposits.
Head-To-Head
Both CNY and CYB offer exposure to the Chinese yuan, but these products are far from identical. As the name suggests, CNY is structured as an exchange-traded note, meaning that it is an unsecured debt security, and as such exposes investors to some amount of credit risk (in this case, the risk of default by Morgan Stanley).
CYB, on the other hand, offers exposure in a very different structure. Like all of WisdomTree’s exchange-traded currency products, this fund is an actively-managed ETF, meaning that it isn’t linked to any particular index. The underlying holdings of CNY consist of U.S. cash investments (generally government securities and repurchase agreements collateralized by government securities) combined in a one-to-one ratio with currency forward contracts.
From a cost perspective, CYB has a slight advantage; the WisdomTree ETF charges 0.45%, 10 basis points less than CNY.
Read more about how the nuances of various currency fund structures impact returns in this feature; sign up for our free ETF newsletter for more ETF investment ideas.
Disclosure: No positions at time of writing.
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