The ETF currency wars

Nick Sudbury looks at the burgeoning range of currency ETFs and picks out the winners and losers in the race to the bottom

In the last couple of years there has been a sizeable increase in the number of currency ETFs on the market and this has been accompanied by significant growth in the assets under management (AUM).

Currency ETFs can be used to speculate on the anticipated movement in a particular exchange rate. They also allow investors to hedge the foreign exchange risk associated with the overseas holdings in their portfolio.

Rarely have the currency returns been as significant as they have in the last few years. Initially it was the ultra loose monetary policy adopted by countries like the US and the UK that provided the momentum, but recently it’s been the European sovereign debt crisis and the first ever downgrade in the US credit rating. 

The euro has been lurching from one crisis to another with Greece, Ireland and Portugal all receiving bail outs. Fears that the contagion may spread to the much bigger economies of Italy and Spain have forced the European Central Bank to intervene to keep the countries’ government bond yields down to sustainable levels.

As if that wasn’t enough, US politicians were only just in time to prevent the world’s largest economy from defaulting on its debts. The 11th hour agreement prompted Standard & Poor’s to downgrade America’s triple A credit rating. These events have put further pressure on the dollar, as have the fears of a double dip recession and the increased likelihood of QE3.

Safe havens
One of the biggest beneficiaries has been the archetypal safe haven of the Swiss franc, which was recently trading at an all time high against the US dollar. This has enabled the CurrencyShares Swiss Franc Trust to produce a one-year return of 28.5% and a spectacular five-year gain of nearly 84%.

Carl Resnick, head of ETF distribution at Security Global Investors, says that there has been a 59% year-to-date increase in AUM in their CurrencyShares ETFs.
“With all our CurrencyShares the underlying currency makes up the investment, which is why they are the purest way of accessing a currency through an ETF.

There is no counterparty risk as there is when investing in a derivatives-based product. The currency sits in a JP Morgan London account so the risk is on JP Morgan’s balance sheet.”