As international investments keep outperforming U.S. securities, investors are paying increased attention to a key source of this alpha -- the underlying currency play. It has opened a window for alert fund managers, who have taken advantage of the dollar’s decline to develop exchange-traded funds that provide unmanaged exposure to individual currencies.
Rydex Investments, the Rockville, Maryland°©based mutual fund company, introduced its first CurrencyShares in December 2005, providing direct exposure to the rallying euro. By June 2006 the company was offering products in six additional currencies: Australian dollar, British pound, Canadian dollar, Mexican peso, Swedish krona and Swiss franc. In February, Rydex launched a Japanese yen product. Last month Rydex had about $2 billion in currency ETFs.
“We believe that retail investors need to diversify their portfolios as much as institutions do, to mitigate risk and enhance returns,” explains Timothy Meyer, ETF business manager at Rydex. “By offering pure, focused currency exposure, these shares help do just that.”
Investors in effect buy liquid local-currency savings accounts that pay a basic interest rate less the funds’ 40-basis-point expenses. Investors can collect income while waiting for the dollar to weaken further. Or they can short the ETFs to bet on a greenback rally.
Lately, the currency ETF space has been getting crowded. In September 2006, PowerShares introduced the G-10 Currency Harvest Fund, which offers a twice-leveraged exposure to the three highest-yielding G-10 currencies and a similarly leveraged short position in the three lowest-yielding G-10 currencies. It has pulled in more than $540 million. And in early May, ETF king Barclays introduced three currency-linked exchange-traded notes, currently worth a total of $115 million, on the New York Stock Exchange. These euro, pound and yen products are senior unsecured notes backed by Barclays, which in turn invests in overnight accounts, futures contracts or other derivatives to track the currencies.
Since it was founded in 1993, Rydex has focused on bringing institutional versions of nontraditional and alternative investments to retail investors. With the currency ETFs, the ®≠rm has a hit on its hands. Though the securities were designed for individual investors, professionals have flocked to them. According to Meyer, half the investors in CurrencyShares are institutions; financial advisers make up a significant chunk of the remainder.
“We have found that a number of money managers are not mandated to purchase derivatives of any kind,” explains Meyer. “In some instances where buying foreign currency may also be prohibited, owning an ETF that provides currency exposure is not.”
