Currency ETFs Offer a Window on the Forex Market

The U.S. dollar caught fire this year while the rest of the world’s major currencies skidded. The traditional way to go long or short the greenback and other currencies is through futures or forward contracts, but U.S. investors can now speculate on one or a basket of them through 37 exchange-traded products from seven sponsors.

These offerings make up one of the lesser-known corners of the ETF world. The currency ETF group is also one of the more complex because its products’ structures vary widely, says Dennis Hudachek, a senior analyst at news and analysis website ETF.com in San Francisco.

Investors turn to these ETFs “mostly for short-term tactical strategies like betting on a strong dollar, and there are folks that use them for hedging purposes as well,” Hudachek says. So it’s not unusual to see big swings in asset levels as traders move in and out, he adds, though “there are investors that play a currency longer-term.”

Given that the U.S. dollar is king right now, the currency ETF with the most assets is the PowerShares DB US Dollar Index Bullish Fund (UUP) from Atlanta-based Invesco. UUP is a passively managed fund that uses futures to track an index — one of the simpler structures. As of October 31, UUP had $967.5 million in assets, and its net asset value was up 20.3 percent for the year.

 World of Money U.S.-Based Currency Exchange-Traded Funds With More Than
$100 Million in Assets

Name	Ticker Code	Assets ($ Millions) 1	2014 Year-to-Date Net Asset Value Performance 1
PowerShares DB US Dollar Index Bullish	UUP	$965.7	20.3%
ProShares UltraShort Euro	EUO	445.1	19.06
ProShares UltraShort Yen	YCS	389.9	17.17
CurrencyShares Australian Dollar	FXA	290.1	13.92
CurrencyShares Swiss Franc Trust	FXF	261.4	8.06
CurrencyShares Canadian Dollar Trust	FXC	251.4	6.94
CurrencyShares Euro	FXE	216	6.46
WisdomTree Bloomberg US Dollar Bullish	USDU	151	6.27
WisdomTree Chinese Yuan	CYB	143	5.74
CurrencyShares Japanese Yen Trust	FXY	107.2	3.82
1 As of October 31.		Source: ETF.com.

When the U.S. stock market is bullish and the dollar is on the upswing, a position in UUP is a “win-win” for portfolios, says Patrick Williams, principal of Williams Group, a registered investment adviser headquartered in North Palm Beach, Florida. What’s less obvious is that when the U.S. stock market corrects, “typically, UUP will go up,” Williams says. He points out that there’s a negative correlation between UUP and the S&P 500 index, which ETF investors track by investing in SPY, the $185 billion ETF from State Street Global Advisors of Boston.

The reason UUP and SPY tend to move in opposite directions is that “over a third of the companies that make up the S&P 500 are multinational companies whose revenues and profits are sourced from a currency other than the U.S. dollar,” Williams notes. Therefore, when investors are long the S&P 500 via SPY, they’re also “short the dollar.” A position in UUP can help stabilize a portfolio during market corrections by acting as an offset, according to Williams.

The next two biggest funds are anything but simple: the ProShares UltraShort Euro (EUO), with $445.1 million in assets as of October 31 and a year-to-date net asset value gain of 19.06 percent; and the $389.9 million ProShares UltraShort Yen (YCS), which gained 17.17 percent during the same period.

The UltraShort funds are “double-down” leveraged funds — that is, they seek returns that correspond to two times the inverse of the daily U.S. dollar price of the euro or the yen. If a trader bets correctly on the direction of a currency, the UltraShort funds can deliver outsize returns.

However, they’re “meant for sophisticated portfolios,” says Stephen Sachs, head of capital markets at Bethesda, Maryland–based ProShares. A position in one of the UltraShort funds “requires more care and feeding,” Sachs explains: To avoid tracking errors, investors must rebalance daily by purchasing or selling shares. But he says the funds provide “ease of use” compared with futures, which leave traders subject to margin requirements. “Some investors can’t use futures for various reasons,” Sachs adds.

At the other end of the spectrum, Chicago-based Guggenheim Investments offers nine CurrencyShares products organized as grantor trusts. The largest is the $290.1 million Australian Dollar Trust (FXA).

These funds track the performance of single currencies, but they own these currencies via depository accounts at JPMorgan Chase Bank. If there are gains, they can return interest to shareholders as monthly distributions. “It’s almost like a savings account,” says William Belden, managing director of product development at Guggenheim Investments. But like their currency ETF counterparts, the CurrencyShares products are also “very actively traded” because “they can be shorted,” Belden says.

With six actively managed currency funds, WisdomTree Asset Management also has a niche in this sector. (The only other actively managed currency ETF is the $20.8 million PIMCO Foreign Currency Strategy ETF from Newport Beach, California–based Pacific Investment Management Co.)

The WisdomTree currency ETF with the largest asset base is the $143 million WisdomTree Chinese Yuan Strategy Fund (CYB). The fund aims for a total return that reflects the money market rates available to foreign investors in China and changes in the market value of the renminbi.

WisdomTree’s products are “total return vehicles,” says Jeremy Schwartz, director of research at New York–based WisdomTree. The funds gain exposure to their underlying currencies through nondeliverable forward contracts that include embedded income based on the country’s interest rates. In years when there are net gains, that feature can result in a year-end distribution to shareholders over and above the gain in net asset value, Schwartz says.

The WisdomTree currency ETF that’s gotten the most inflows of late is the $151 million WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU), launched in December 2013. USDU goes long the U.S. dollar against the currencies of the ten developed and emerging-markets countries represented in the new Bloomberg Dollar Spot Index.

Bloomberg describes this index as particularly relevant to the modern world because it includes the currencies of countries “absent from traditional indexes, such as leading U.S. trading partners China, South Korea, and Mexico, as well as the highly liquid Australian dollar.” The index will also be rebalanced annually to provide “a dynamic representation of global trade flows and liquidity measures,” it states. Thanks to the dollar’s recent strength, USDU posted a three-month gain of 6.24 percent in its net asset value as of September 30.

As an actively managed competitor to PowerShares’ index-based UUP fund, USDU is regarded as “groundbreaking,” ETF.com’s Hudachek says. Previously, UUP had been the only exchange-traded product that offered long exposure to the U.S. dollar, he notes.