Inside The Not-So-Simple Currency ETFs

by on July 28, 2010 | ETFs Mentioned:

While the majority of the nearly $800 billion in ETF assets is found in equity funds, it is other corners of the market that have accounted for the significant cash inflows and asset growth exhibited in recent years. Fixed income and commodity funds have been particularly hot, taking in more than $25 billion in aggregate during the first six months of 2010 [also see Top Performing Currency ETFs From The First Half Of The Year]. 

Currency ETFs haven’t experienced nearly the same level of popularity as have bond and commodity funds, but have nevertheless seen huge growth over the last year despite significant outflows in the first half of 2010. At the end of June, currency ETF assets stood at $5.3 billion, an increase of more than 42% from the same period a year earlier. In an environment where correlations between most major asset classes–stocks, bonds, commodities, and real estate–has shot towards 1.0, investors are eager to add non-correlated assets to their portfolios. Many have found that currencies can serve a valuable role as a diversifying agent for most portfolios [see Seven Currency ETFs Highly Dependent On Commodity Prices].

Most currency ETFs are relatively straightforward, offering exposure to the exchange rate between two currencies (one of which is generally the U.S. dollar). But there are a few funds within the Currency ETFdb Category that are a bit more complex, utilizing unique strategies to offer investors exposure to this asset class [for more ETF ideas, sign up for our free ETF newsletter]:

  • iPath Optimized Currency Carry ETN (ICI): This exchange-traded note is linked to the Barclays Capital Intelligent Carry Index, a benchmark that replicates the strategy of borrowing in low-yielding currencies and using those proceeds to invest in high-yielding currencies, known to many investors as the “carry trade.”  The carry trade is nothing new; investors have been practicing a form of interest rate arbitrage for decades (sometimes with disastrous results). ICI’s pool of potential currencies is limited to G10 countries which include; the U.S. dollar, the euro, the Japanese yen, the Canadian dollar, the Swiss franc, the British pound sterling, the Australian dollar, the New Zealand dollar, the Norwegian krone, and the Swedish krona. Recently, ICI’s biggest long positions were in the Aussie dollar, krone, and yen. Meanwhile, the franc, krona and the Canadian dollar made up the most substantial short positions. ICI charges an expense ratio of 0.65% but it is up 0.7% so far in 2010 [also read Currency Carry Trade ETFs Head-To-Head].

  • Asian and Gulf Currency Revaluation ETN (PGD): This note tracks the Barclays Capital Global Emerging Markets Strategy Pegged Index, an index based on a unique premise. Research has shown that currencies pegged to the U.S. dollar have total returns similar to a U.S. dollar cash investment, and may be subject to potential revaluation risk. The goal of this note is to provide investors exposure to a basket of five currencies either pegged or under a managed float regime relative to the greenback: the Chinese yuan, Hong Kong dollar, Saudi Arabia riyal, Singapore dollar, and United Arab Emirates dirham.  PGD charges an expense ratio of 0.89%.
  • iPath Global Emerging Market Strategy Asia 8 ETN (AYT): This ETN tracks the performance of the Barclays Global Emerging Market Strategy Asia 8 Index. Similar to the index underlying PGD , this benchmark seeks to replicate exposure to local currencies through short-term, liquid, and diversified instruments. The index to which AYT is linked includes eight Asian currencies: the Indonesian rupiah, the Indian rupee, the Philippine peso, the South Korean won, the Thai baht, the Malaysian ringgit, the Taiwanese dollar and the Chinese yuan.  AYT is designed to pay monthly coupons and charges an expense ratio of 0.89%.
  • iPath Capital Global Emerging Markets Strategy ETN (JEM); This ETN tracks the Barclays Capital Global Emerging Markets Strategy Index, a benchmark comprised of one month synthetic money market deposits in 15 emerging market currencies that are formed through three regional sub-indexes: Eastern Europe, Middle East and Africa, and Latin America and Asia [see a complete list of component currencies on the JEM fact sheet]. The note also charges an expense ratio of 0.89%.
  • WisdomTree Dreyfus Emerging Currency Fund (CEW): This product has two major differences relative to those outlined above: 1) it’s structured as an ETF, not an ETN, and 2) CEW is actively managed. This fund is designed to achieve total returns reflective of both money market rates in selected emerging market countries available to foreign investors and changes to the value of these currencies relative to the U.S. dollar. Although money market rates in much of the developed world are near zero, many emerging markets offer yields as high as 7% [see more about CEW on the fund fact sheet].

Disclosure: No positions at time of writing.