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Barchart.com ETF ResearchBarchart.com's Picks for Currency ETPs ETF Research written by the Barchart.com ETF Research Team Last Updated: December 8, 2011 Table of Contents
IntroductionCurrency exchange-traded products (ETPs) provide investors with a vehicle to gain currency exposure by buying/selling an exchange-listed product rather than by dealing in the currency spot or futures markets. Investors can find currency ETPs useful for investing cash in a foreign currency, speculating on the direction of a currency, or hedging a bond or equity investment. There are many different currency ETPs. The selection of a specific currency ETP often comes down to the one with the most assets under management since for most currencies there is usually one large ETP and the other ETPs in the group have minimal assets under management. In any case, we recommend that investors stay away from ETPs with less than $50 million in assets under management. Issuers are not making much, if any, profit on managing an ETP with less than $50 million in assets under management and there is the risk that the issuer will eventually decide to shut down the fund. If the issuer voluntarily shuts down a fund, the investor will get back the money that he or she had invested in the fund, but the money could be locked up for some period of time and there could be some inconvenient hoops to jump through to get the money returned. Currency ETPs include both exchange-traded funds (ETFs) and exchange-traded notes (ETNs). Currency ETFs typically hold actual assets, i.e., the spot currency, currency futures, or over-the-counter forward currency contracts. ETNs, on the other hand, simply represent an unsecured promise by the issuer or a bank to provide a return based on a currency benchmark. We generally advise against placing any significant amount of money in an ETN because an investor’s money could be completely lost if the ETN issuer or bank should go bankrupt. Another issue to consider in selecting a currency ETP is its legal structure and tax treatment. For example, the Rydex CurrencyShares products are set up as a grantor trust and hold the actual spot currency in a bank account. An investor in the Rydex CurrencyShares products will receive a 1099 tax notice and the income is taxed at the taxpayer’s ordinary income tax rate. The WisdomTree currency ETP products, by contrast, are generally set up as open-ended funds that hold forward currency contracts, swaps, repos, money markets, and Treasury securities. WisdomTree products generally issue a 1099 tax notice and 15% of the income is taxed at the long-term capital gain tax rate and 85% at the ordinary income tax rate. Meanwhile, ProShares currency products are generally set up as a limited partnership and hold futures. The income is reported on a K-1 and is taxed as 60% long-term capital gains and 40% ordinary income. PowerShares has both currency ETFs and ETNs, but its ETF products generally hold futures and are set up as limited partnerships and are taxed as 60% long-term capital gains and 40% ordinary income. An investor should consult with his or her tax advisor on the most appropriate structure and tax treatment and should carefully examine the prospectus of the currency ETP for the fund’s exact specifications. We will now provide a quick description of currency ETPs broken out into specific currencies. Figure 1: Comparison of PowerShares DB U.S. Dollar Index Bullish Fund (UUP) versus Spot Dollar Index (live chart link)
North AmericaU.S. Dollar (USD) - PowerShares has a dollar bullish ETF and a dollar bearish ETF, both of which have assets under management well in excess of $50 million. The U.S. Dollar Index was created by the Federal Reserve in 1973 and currency futures on the dollar index are traded at the ICE Exchange. The Dollar Index tracks a basket of currencies with the following weights: euro (57.6%), Japanese yen (13.6%), British pound (11.9%), Canadian dollar (9.1%), Swedish krona (4.2%), and Swiss franc (3.6%). It should be noted that the U.S. Dollar Index is heavily weighted towards European currencies and does not approximate the volume of U.S. trade or an optimal portfolio of foreign stocks. Therefore, the Dollar Index ETPs may not be particularly appropriate for many hedging applications. As an additional caveat on the PowerShares DB U.S. Dollar Index Bullish Fund (UUP), Figure 1 illustrates that UPP has shown significant underperformance relative to the spot U.S. Dollar Index. UUP follows the strategy of investing in the first futures month, which means that the process of progressively rolling forward on futures contracts as they expire can cause underperformance of UUP versus the spot index. The expense fee for UUP will also cause underperformance relative to the spot index.
Canadian Dollar (CADUSD)
Mexican Peso (MXNUSD)
Figure 2: Comparison of CurrencyShares Euro Trust (FXE) and spot EURUSD (live chart link)
Europe - Euro (EURUSD)CurrencyShares Euro Trust (FXE) is our clear choice for a EURUSD ETF given that it has plenty of assets under management and is an ETF as opposed to an ETN. In addition, it tracks the spot currency EURUSD very closely, as seen in Figure 2. The ProShares UltraShort Euro (EUO) has a large amount of assets under management at $1.0 billion and provides a means of getting long the dollar and short the euro with leverage of two times. CurrencyShares Euro Trust (FXE) (issuer web site link) – This fund, launched in December 2005, has $375 million in assets under management. The fund has an expense fee of 0.40%. iPath EUR/USD Exchange Rate ETN (ERO) (issuer web site link) – This fund, launched in May 2007, has $5 million in assets under management. The fund has an expense fee of 0.40%. Leveraged Long Euro ETPs
Europe Outside the EurozoneBritish Pound (GBPUSD) – The CurrencyShares British Pound Sterling Trust (FXB) is our clear choice in this group since it has sufficient assets under management and is an ETF rather than an ETN.
Swiss Franc (CHFUSD)
Swedish Krona (SEKUSD)
Russian Ruble (RUBUSD)
AsiaJapanese Yen (JPYUSD) – CurrencyShares Japanese Yen Trust (FXY) is our clear choice in this group since it is an ETF and has plenty of assets under management. For leveraged short exposure to JPYUSD (i.e,. short the yen, long the dollar), ProShares UltraShort Yen (YCS) has more than sufficient assets under management at $270 million.
Figure 3: Comparison of WisdomTree Dreyfus Chinese Yuan Fund (CYB) and Spot CNYUSD Currency (live chart link)
Chinese Renminbi (CNYUSD) – In this group, WisdomTree’s CYB has the largest amount of assets under management and has the advantage of being an ETF. However, there is a big caveat for this fund in that it has recently done a very poor job in tracking the spot CNYUSD currency, as seen in Figure 3.
Indian Rupee (INRUSD) – Neither of the two ETPs tracking the Indian rupee in our view currently has sufficient assets under management to consider for investment purposes, although WisdomTree’s ICN is so far winning the race to gather assets.
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