The foreign exchange market is experiencing greater volatility as global central banks outline diverging monetary policies. Consequently, traders have been taking a greater interest in currency-related exchange traded funds to capture the moves.
Traders have been using currency ETF to take short-term bets on shifting global currencies or hedge against depreciating currencies overseas. Most trades are short-term in nature because currencies, unlike company stocks, don’t appreciate forever, but instead follow a more cyclical trend.
In 2014, the U.S. dollar has been one of the best currency trades. For instance, the PowerShares DB U.S. Dollar Index Bullish Fund (NYSEArca: UUP) has strengthened 8.5% year-to-date. UUP tracks the price movement of the U.S. dollar against a basket of currencies – the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. [Currency ETFs to Access the Diverging USD and Euro]
The stronger U.S. dollar has not gone unnoticed. UUP attracted $207.8 million in inflows year-to-date and now holds $942.9 million in assets under management, according to ETF.com data.
Patric Williams, principal of Williams Group, points out that the bullish equities market and an upswing in the USD have contributed to UUP’s gains, reports Rosalyn Retkwa for Institutional Investor.
Williams reminds investors that the U.S. stock market and UUP have shown a negative correlation since over a third of S&P 500 companies are multinational companies, whose revenues and profits are denominated in overseas currencies. Consequently, weaker foreign currencies would mean that revenue generated overseas would translate into lower USD-denominated returns.
Additionally, the ProShares UltraShort Euro (NYSEArca: EUO), which is designed to provide 200% of the inverse return of the U.S. dollar price of the euro on a daily basis, and the ProShares UltraShort Yen (NYSEArca: YCS), which tries to reflect the daily -2x or -200% daily return of the USD/JPY currency pair, have both been popular plays to capture the depreciating euro and Japanese yen currencies. EUO has $452.6 million in assets under management and increased 20.6% year-to-date. YCS has $466.2 million in assets and rose 16.4% so far this year. [Japan ETFs Find Double Support From BOJ, Pension Fund]
Stephen Sachs, head of capital markets at ProShares, warns potential investors that these types of so-called geared funds are “meant for sophisticated portfolios” and require “more care and feeding.” Specifically, due to the compounding effects on the daily rebalances, the ETFs may not perfectly reflect their target strategies over the long-term.
Unlike UUP, which tracks a basket of currencies through futures contracts, the suite of CurrencyShares ETFs track single currency price movements against the U.S. dollar. For instance, CurrencyShares Australian Dollar Trust (NYSEArca: FXA), which tracks the Australian dollar’s movement against the USD, holds a depository account denominated in AUD and may issue regular distributions.