Reuters: US Dollar Report: Currency ETFs -- taking time to take off

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Currency ETFs -- taking time to take off May 1st 2012, 20:13 Tue May 1, 2012 4:13pm EDT * Currency ETFs account for 0.4 pct of total ETF assets * Low yields dampening interest in sector * But some see huge potential in emerging market space By Gertrude Chavez-Dreyfuss NEW YORK, May 1 (Reuters) - Exchange-traded products in equities, commodities, and fixed income may be all the rage these days among global investors, but their bigger and more liquid counterpart -- currencies -- aren't getting the same respect. Low yields have dimmed the sheen of currency ETFs despite an underlying market that trades about $4 trillion per day, the largest in the world. Foreign exchange gains are also embedded in international equity and bond portfolios, rendering currency ETFs irrelevant for some asset managers. These ETFs invest in an interest-yielding bank account denominated in the currency it tracks and they will provide only the cash returns plus the accumulated change in exchange rates. "Currency funds are a poor long-term investment due to paltry expected returns," said Michael Rawson, analyst at Morningstar in Chicago, adding that low cash yields are likely to underperform even inflation over time. Total returns for currency ETFs in the first quarter were 2.08 percent and for March the sector incurred losses of 1.48 percent, Morningstar data show. In contrast, consumer cyclical ETFs posted nearly 17 percent in returns, while precious metals had 10.46 percent. Net assets in currency ETFs were $5 billion, accounting for just 0.4 percent of ETF assets totaling $1.2 trillion. In the first quarter, currency ETFs had net outflows of $1.479 billion and about $461 million outflows in March. In contrast, equities account for 70 percent of the total, fixed income around 17 percent, and commodities, 12 percent. Currency ETFs, which trade likes stocks, track the change in the value of the underlying currency. U.S. investors with ETFs following non-U.S. assets most likely have sizable exposure to foreign currencies, one reason some choose not to invest in pure currency ETFs. A holder of a combined ETF would get not only the local return of the ETF but also the currency's change relative to the dollar. For instance, the year-to-date return of iShares MSCI Australia Index was 10.1 percent, which includes the Australian dollar's gain of 2 percent this year. If an investor bought the CurrencyShares Australian dollar Trust ETF, the return would be just 2.37 percent. "I think most investors would prefer to have the currency strategy implemented inside a foreign equity or fixed income ETF," said Cary Blake, head of ETFs at RBC Global Asset Management in Toronto, with total assets of C$250 billion (US$253.65 billion). HEDGING TOOL; POTENTIAL IN EMERGING MARKETS Some investors, however, use currency ETFs to hedge their portfolios, although Simon Klein, head of ETFs for Europe at Lyxor Asset Management in Paris, said there are costs to those hedges and the fund would need be adjusted daily. Lyxor manages assets of around 77.3 billion euros ($102.07 billion). An investor expecting a large euro expense, for instance, could hedge against the risk that the euro will appreciate by going long the CurrencyShares Euro Trust, locking in the dollar cost. On the other hand, shorting this euro ETF, which invests in interest-bearing euro-denominated bank accounts, could provide a useful hedge to U.S. investors with substantial holdings in euro zone equities. The hedge will reduce the volatility of the foreign investment by cutting the currency risk. Some in the industry also believe there's huge potential in emerging markets. The New York-based WisdomTree Asset Management Inc., which oversees assets of $15 billion, ha s positioned itself in emerging markets thr ough ETFs that provide not only currency but also local debt exposure. For WisdomTree, currency ETFs are tactical or strategic plays that supplement their fixed income funds. Rick Harper, WisdomTree's director of fixed income and FX, viewed the firm's currency ETFs as proxies for short-duration fixed income instruments, which are difficult to access in emerging markets. By having a currency ETF like CEW, a basket of EM currencies, and a fixed-income fund at the same time such as WisdomTree's Emerging Markets Local Debt fund, which has a current duration of 4.4 years, investors will have exposure to both short- and long-term yields. "If we get inflation, or if expectations for inflation rise down the road, central banks will tend to lift short-term rates and that will benefit the currencies of those countries," Harper said. WisdomTree did concede that assets do tend to shift between asset classes in the ETF space and Jeremy Schwartz, the firm's director of research, said that is a function of risk appetite. "When equities are doing better, you will find that investors are less interested in currencies. So flows in currencies go into equities," said Schwartz. Link this Share this Digg this Email Reprints

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