PowerShares currency ETFs hold futures contracts and are registered as open-ended ETFs. Potential gains on futures contracts are subject to the so-called 60/40 tax treatment, where 60% of gains are long-term and 40% are short-term.
WisdomTree’s currency income ETFs hold U.S. money market securities or a combination of money market instruments that try to provide exposure to non-U.S. money market securities or rates.
Market Vectors provides currency ETNs, which are senior, unsecured debt securities that offer exposure to exchange rates between the U.S. dollar and foreign currencies. [Distinguishing the Difference Between ETNs and ETFs.]
In addition, Market Vectors and ProShares include some leveraged-long and leveraged-short ETNs that provide enhanced currency exposure. The funds try to provide the double daily bullish/bearish performance of a specific currency.
Barclay’s iPath currency ETNs try to reflect the fluctuations in various currency pairs.
Capitalizing The Carry Trade Technique
Due to the high liquidity in the forex market and a widening disparity between country yields, the carry trade can be a possible strategy. Carry trades attempt to capitalize on the interest rate disparity between two countries and establish positions for potential appreciation in values.
Essentially, the carry trade involves taking on loans from low interest-rate bearing countries and putting that money into countries with high interest rates. As a result, the trader would take advantage of the interest rate spread between the two countries, and the carry trader may also benefit from potential capital appreciation between the two currencies. Currency investors have traditionally profited from the carry trade between the high interest found in the Australian dollar against the low-interest bearing Japanese yen.
However, a trader would take a hit if the exchange rate devalues by more than the average annual yield or if inflation were to suddenly skyrocket, which would eat away at the real value of the currency, and the risk of losses is increased if a currency trader uses leverage.
There are numerous ETFs and ETNs targeting currencies, allowing investors to have a range of choices when it comes to deciding how to use them in portfolios. When choosing currency ETFs, consider the differences between the funds, how they access currencies and their tax treatment. Keep in mind the macroeconomic market forces that sway the movements of economies and global currencies. There may be new opportunities in foreign markets, and currency ETFs can be a good way to access the trends.
Full disclosure: Tom Lydon is a board member of Rydex|SGI.