By Clayton Fresk, Stadion Money Management
After spiking in the latter half of 2014 and churning higher in the latter part of 2016, the US Dollar has seen a rather steady decline in 2017 and thus far in 2018. However, there is still room to move lower before the currency hits levels where it traded during 2012-2014. So what ETFs are available to play this weaker dollar? I will touch on six different options below.
To isolate purer exposure to the dollar, I isolated ETFs with a strong negative correlation (< -0.80) over shorter term and longer-term periods. Not surprisingly there were only a handful of ETFs that rose to the top.
The most obvious would be UDN (PowerShares DB US Dollar Bearish). As the name states, the fund is positioned to be dollar bearish, taking long positions in a basket of currencies (futures contracts, with cash held as collateral). The current breakdown of exposure is as follows:
- Euro: 57.6%
- Japanese Yen: 13.6%
- British Pound: 11.9%
- Canadian Dollar: 9.1%
- Swedish Krona: 4.2%
- Swiss Franc: 3.6%
While UDN accomplishes the goal of positioning itself for a weaker dollar, there are a couple caveats which may give investors pause. First, the fund carries a 0.80% expense ratio, which could be a slight detriment in this new low-cost landscape. Second, based on the fund structure, it issues a K-1 rather than a 1099, which could be a tax situation for some investors. That being said, UDN has had a very limited distribution history, although there was a small return of capital distribution in 2017. Third, the fund has a rather small AUM (~$42MM) and trading volume (~80K shares or ~$1.8MM/day). While this should not be a trading issue given the extremely liquid underlying investments, it is something to at least be aware of. (As a point of comparison, UDNs bullish counterpart, UUP, has ~$512MM in AUM and trades about 1.6MM shares/day or ~$37MM/day).
If these caveats have investors struggling with using UDN, another purer currency choice could be FXE (CurrencyShares Euro Trust). Rather than a basket of securities, FXE will give 100% long exposure to the Euro (versus 57.6% as mentioned above for UDN). Although the fund has not had a distribution, it issues a 1099 rather than a K-1. It is also half the cost of UDN with a 0.40% expense ratio. Additionally, it has a larger AUM base and trading volume than UDN. The main drawback is that an investor would not have a diversified currency exposure in using FXE only. However, CurrencyShares offers ETFs for the other aforementioned currencies, so an investor could recreate the basket via multiple ETFs.
Outside these currency ETFs, another option would be to invest in an unhedged international bond ETF. Given the very low interest rate environment in which we currently reside, a significant portion of these bond ETFs returns are driven by the currency effect rather than the underlying bonds themselves.
If an investor would want to minimize the bond/rate ‘effect’ in order to strive for a strong negative dollar correlation, one place to start would be on the shorter part of the government curve. There are two ETFs that offer short duration government exposure:
- ISHG (iShares 1-3 Year International Treasury Bond)
- BWZ (SPDR Bloomberg Barclay’s Short Term International Treasury Bond)
These two ETFs are very similar in terms of exposure and cost, while BWZ has a larger AUM base and trading volume. However, the biggest difference is that ISHG invests only in developed markets exposure, while BWZ invests in emerging markets debt as well. In terms of currency exposure, this additional exposure accounts for about 19% of the fund. Here is a side-by-side chart, with the aforementioned UDN exposure added as reference:
While this other in BWZ exposure can add some dispersion in terms of currency exposure versus ISHG, this other exposure also adds a layer of additional yield as an offset. Currently, this yield ‘buffer’ is approximately 0.57% based on the yields of the underlying indices for the respective fund (the yield differential has fluctuated between the 0.45% and 0.80% range since mid-2014, averaging about 0.65%).
Going back to the correlation question, here is a chart of the rolling 252-day correlation of the underlying indices of BWZ and ISHG vs the dollar, with the UDN index as a point of reference:
While both the underlying bond exposure and the different currency weights dampen the correlation a bit versus UDN, there remains a strong negative and rather steady negative correlation to the US dollar (for the entire period, the ISHG index had a -0.76 correlation while BWZ had a -0.73 correlation).
For those who may have fears about having exposure at the front end of the curve (whether it be negative interest rates abroad or potential rate climbs/curve flattening like the market has seen here in the US), an investor could also step out into broad government exposure rather than staying on the short end of the curve. Two options here would be:
- IGOV (iShares International Treasury Bond)
- BWX (SPDR Bloomberg Barclays International Treasury Bond)
In terms of currency exposure, both names have very similar exposure to their short-duration counterparts. They also have a similar underlying yield dispersion (0.72% versus 1.19%). But going back to the original question at hand, these names will have a slightly less favorable negative correlation to the dollar given the other forces at play (higher yield, more volatile underlying rates out the curve, etc.), although they are still decently low at -0.68 and -0.63 respectively. Here is the same rolling correlation chart with the additional names added:
In conclusion, for investors looking for ways to take advantage of a weaker dollar, there are a handful of names in ETF land they could use.
Clayton Fresk is a Portfolio Manager at Stadion Money Management, a participant in the ETF Strategist Channel.
Disclosure Information
Past performance is no guarantee of future results. Investments are subject to risk and any investment strategy may lose money. The investment strategies presented are not appropriate for every investor and financial advisors should review the terms and conditions and risks involved. Some information contained herein was prepared by or obtained from sources that Stadion believes to be reliable. There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained. Any market prices are only indications of market values and are subject to change. Any references to specific securities or market indexes are for informational purposes only. They are not intended as specific investment advice and should not be relied on for making investment decisions. One cannot invest directly in indexes, which are unmanaged and do not incur fees or charges. At the time of writing, Stadion did not own any of the securities referenced. Founded in 1993, Stadion Money Management is a privately owned money management firm based near Athens, Georgia. Via its unique approach and suite of nontraditional strategies with a defensive bias, Stadion seeks to help investors—through advisors or retirement plans—protect and grow their “serious money.” Contact Stadion at 800-222-7636 or www.stadionmoney.com. SMM-022018-176