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Foreign Currency ETFs - A Look at Foreign Currency Fund Choices

What is a foreign currency ETF or exchange traded fund? The first foreign currency ETF was offered by Rydex in 2005, traded as FXE, and it tracks the European Euro against the US dollar.

Now you should be aware that when you are involved in currency trades, you are actually participating in a market that is much larger than the US stock market. The Forex, or foreign currency exchange market dwarfs the US stock market, and is probably the largest financial exchange in the world.

Normally trading foreign currencies requires some type of Forex account, and is quite separate from your normal brokerage account. For this reason many investors never become aware of the Forex in spite of its size.

When Rydex introduced their foreign currency ETFs, they noted the following:

The CurrencyShares products are intended to offer investors a new and different opportunity to participate in the foreign currency market through an investment in securities. Historically, the logistics and expense of investing in foreign exchange have been a barrier to entry for many investors. The CurrencyShares products are aimed at overcoming the barriers to entry. A prospective purchaser of CurrencyShares should not encounter any tasks or costs beyond those associated with purchasing another publicly-traded equity security.

CurrencyShares are intended to provide institutional and retail investors with a simple, cost-effective means of gaining investment benefits similar to those of holding foreign currency.

In effect, you can trade Forex like products in your usual brokerage account, albeit without the leverage (with its attendant high profit and loss potential) that a Forex account can provide.

The construction of these ETF is complex, resulting in a few unusual characteristics. For example, there is no 15% long term capital gains treatment available regardless of the holding period.

Since that the first introduction of the FXE, there have been several more currency ETFs introduced by Rydex under their brand name Currenyshares

These now include:

  • Canada Dollar FXC
  • Australia FXA
  • Swedish Krona FXS
  • British Pound Sterling FXB
  • Japanese Yen FXY
  • Mexican Peso FXM
  • Swiss Frank FXF

Since you are holding what amounts to cash, these pay a nominal yield (similar to a money market fund). But the reason to hold is the expectation that the value will move against the dollar.

A different take on a foreign currency ETF is the PowerShares DB G10 Currency Harvest (DBV). This ETF is actively managed, and tracks 10 currencies, going long on the top three currencies with the highest interest rates and going short on the “top tier” three currencies with the lowest interest rates.

Another actively managed currency ETF from PowerShares is the U.S. Dollar Bearish Fund (UDN) that track the New York Board of Trades U.S. Dollar Index. This index is a popular measure of the dollar’s strength against other currencies; the Euro has a 58% position; Japanese yen 14%; British pound 12%; Canadian dollar 9%; Swedish krona 9%; Swiss franc 3%.

A few more recent offerings are in the iShares family, including the Euro ERO and the British pound GBB.

Why invest in currency ETFs? The expectation is that this can offer a degree of diversification in a portfolio, or may simply serve as a hedge for some foreign currency exposure you have in your portfolio. There are several trading systems that are popular for the Forex, including some trend following systems that are similar in nature to our sector rotation strategies.

Filed under ETF News

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