The Dark Side of Currency ETFs

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Currency investing is a good idea. However, before you get involved keep in mind that education is critical. Investors may attempt to shortcut the learning curve by investing in currency Exchange Traded Funds (ETFs) because they trade like stocks but they won’t act like stocks. However, the similarities end here. Currencies are not like stocks or bonds, which are designed to deliver a return on investment. Therefore currency investing is subject to an entirely different set of expectations.

[VIDEO] Currency ETFs

As investors look for new ways to make money and diversify in the financial markets, currency ETFs have become a way to speculate on movements in the international market by shorting a weakening dollar or buying a strengthening yen. We generally like these products as a low-cost, low-leverage way to make an investment in the currency market. However, we start running into issues with the new “emerging markets” currency ETFs.

The idea behind the emerging markets currency ETFs is to get exposure to a breadth of different currencies like the ruble, rand, bhat, zloty and won among others. However, many investors are inferring that an emerging market currency fund will also share the usual ETF benefits of lower volatility, expectations for growth, diversification and low costs. Unfortunately these benefits are not likely to emerge.

For example, an emerging market ETF is essentially a basket of currencies that are expected to rise in value compared to the U.S. dollar. Another way to look at it is that you basically making a bet that the dollar will fall. That is not a diversified investment.

Emerging market currencies are extremely volatile, prone to currencies crises and are subject to frequent intervention. They are anything but smooth. You can see an example of this kind of volatility with the Turkish lira chart below. By the way, the uptrend is not a good thing for the lira. It means the U.S. dollar has been strengthening against this emerging market’s currency for some time.

Most importantly, many investors are inferring that an emerging market’s currency will appreciate like a new stock might. This is not the case. There are many reasons that an economy will not want its currency to appreciate and very few reasons for them to want it to grow in value versus the dollar. Currencies are not like stocks and there is no historical reason to assume that they will rise in value versus the dollar.

This investment opportunity is not unlike the Iraqi dinar investment scam currently making the rounds on the internet. Most small currencies weaken against the major currencies in the long run so if you can’t expect growth in the value of this ETF, what is its real purpose?

This is a great example of the importance of investor education. There are a lot of very bad products out there waiting for buyers. Some of these are offered by very reputable firms but they have no other purpose than to generate fees from the uninformed. If you are interested in making an investment in currencies you can learn to do it through legitimate currency ETFs or in the spot market itself.


Image courtesy Roger Schultz.