Exchange traded funds are flooding the market, but products providing exposure to currencies remain limited to a couple of US players. Industry participants are divided, in any case, over whether Europeans will embrace currency ETFs because commodities and infrastructure continue to be the favourites in the alternative asset class space on both sides of the Atlantic.
According to Morgan Stanley's ETF Year End 2006 Global Review, exchange traded commodities were the most popular ETFs, enjoying a staggering growth rate - albeit from a low base - of 210% to $9.85bn. Exchange traded currencies witnessed only a 1.3% hike to $1.17bn.
Foreign exchange as an asset class in its own right is a relatively new concept. It has only been since the 2001 stock market crash and the subsequent push to diversify asset classes that fund managers have begun to examine currency markets. However, hedge funds continue to dominate activity and are partly responsible for pushing FX volumes through the roof. The most recent triennial survey by the Bank for International Settlements estimated daily volumes on the FX market were $1.9bn in April 2004. Analysts expect this figure to hit the $3bn mark by the time the BIS publishes its next survey later this year.
Greg Ehret is senior managing director of State Street Global Advisers. He says currency ETFs will not take off in Europe because investors are more accustomed to dealing in currency markets and gaining exposure through futures; hence they are less attracted to a synthetic tracker.
Danièle Tohmé-Adet, head of indexed Funds business development and co-head of EasyETF Platform at BNP Paribas Asset Management Paris, disagrees, adding, "European investors are open to new asset classes and we have seen several being launched in the past year."
Thanos Papasavvas, head of currency management at Investec Asset Management, expects that if investors do use currency ETFs, their strategies would be the same as for currency fund investment. "One of foreign exchange's main attractions is a low correlation with stock and bond markets. As a result, we are seeing an increasing number of pension funds considering investing in currencies to diversify their portfolios and an additional source of alpha. We are not seeing fund managers use them for hedging purposes; many would do this through the futures markets."
This is certainly the case in the US, according to Tim Meyer, ETF business manager for Rydex Investments, who confirms that diversification and alpha generation are the main reasons why investors use Rydex's stable of currency products. Investors garner short term profits from exhange rate fluctuations caused by factors including interest rate changes and imposition of currency controls.
Unsurprisingly, the plummeting dollar has started a rush into Rydex's CurrencyShares Euro Trust exchange-traded fund, which saw assets soar past $1bn.
The product was launched on the New York Stock Exchange two years ago and tracks the underlying price movements of the euro. Building on its its initial success, Rydex unveiled seven other single currency products between June 2006 and February 2007, covering yen, sterling, Swiss francs, Mexican pesos, Swedish krona and Australian and Canadian dollars.
These products pay interest and carry a yield because the ETFs hold currencies instead of futures. The downside for UK and continental European investors is that any profits made will be in US dollars, which is not the currency of choice at the moment.
To offset this, a British investor, for example, could lock in the profits by adding the sterling CurrencyShare ETF to their portfolio fold. The other main players are Deutsche Bank and PowerShares, a unit of Amvescap, which is adopting the basket approach.
This year the partnership launched two products catering to investors who were either optimistic or negative on the greenback. The PowerSharesDB US Dollar Bullish and Bearish funds take long or short positions in the Deutsche Bank US Dollar Index Futures Index - Excess Return, which tracks the dollar against a basket of six currencies.
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