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Should you buy currency ETFs?

Glenn Freeman  |  16 Nov 2017Text size  Decrease  Increase  |  
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Current fundamentals don't necessarily support investors' enthusiasm for currency exchange-traded funds, according to Morningstar manager research analyst, Anshula Venkataraman.

While the Australian currency investment vehicles have attracted almost $600 million in assets, they're not very well suited to long-term investors. These drawbacks are compounded by the low global interest rate environment.

"Most currency [exchange-traded products] ETPs are simple--they track the performance of a currency such as the US dollar or euro," says Venkataraman.

"You'll make money if the Australian dollar slumps, or if the other currency soars. But in the reverse situation, you'll lose money." 

She explains that currency ETPs are often used by speculators who want to bet on the macro, political, and economic events that drive currencies. They can also be used to hedge against risks such as the cost of future financial outlays or to take a longer-term investment view on currency.

One example of the former would be someone planning to immigrate to the United States, who may want to hedge the future cost of an overseas house purchase or student fees by owning US dollar ETPs.

In hedging against portfolio risk, currency ETPs can be a way to alleviate the risk presented during economic downturns, when "there is usually a repatriation of assets to the US dollar, and meanwhile commodity prices get smashed."

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The US$-to-A$ cross-rate spiked during both the 2000 technology sector crash and the 2008 GFC.

"There’s no guarantee of this relationship, but it does offer a way to tilt portfolio risk," Venkataraman says.

Morningstar has generally been cautious in initiating coverage of currency ETFPs, because it favours long-term approaches relevant to retail investors, while the above strategies are more suited to professional traders and institutions.

"Another reason we haven't raced to cover currency ETPs is that in the long run currency doesn't pay--or at least not much," Venkataraman says.

While equities pay dividends, and bonds pay coupons, "in a currency ETP, your money sits in a bank earning a modest rate of interest".

"After fees are deducted, the interest earned on, say, a US dollar exchange-traded fund is miniscule, given the low interest rates on offer there."

The Australian situation

Domestically, there are seven currency ETPs, with a total of $592 million in assets as at 30 September, 2017.

 

Bid/ask spreads of currency ETPs in Australia, January 2013 - September 2017


chart


Surce: Morningstar

 

Venkataraman emphasises that not all currency ETPs are simple cash boxes in a foreign bank account, with some using derivatives, or aiming to track multiple currencies--though such variants are more common in the US than Australia.

Overall, she believes that currency ETPs are not attractive long-term investments.

"They pay minimal interest, and currencies do not appreciate over the long run--in fact, they generally revert to their long-term valuations," she says.

"Investors should also take care with more-complex strategies to understand any derivatives or leveraged exposure, which can vary widely."

However, this doesn't make them bad vehicles for every retail investor, with the higher-quality currency ETPs offering competitive prices and trading costs, and may be a decent way for more sophisticated investors to get some currency exposure.

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Glenn Freeman is a senior editor at Morningstar.

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