Currency ETFs attract assets, despite the risks

Dec 11, 2006 @ 12:01 am

By David Hoffman

PHILADELPHIA - Assets in exchange-traded investments that provide exposure to foreign currencies are growing rapidly as investors look to profit from a declining dollar, a strategy many financial advisers consider too risky for most investors.

At the end of November, assets in eight such vehicles - all virtually identical in structure to exchange traded funds - totaled $1.2 billion, up from $88 million at the end of 2005, according to State Street Global Advisors in Boston.

Seven of the vehicles are from Rydex Investments of Rockville, Md., which kicked things off when it launched the first such fund - the CurrencyShares Euro Currency Trust - in December 2005.

PowerShares Capital Management LLC of Wheaton, Ill., offers the only other such product, the PowerShares DB G10 Currency Harvest Fund.

It's not hard to see why such products are growing in popularity.

Fluctuating currencies

Year-to-date through the end of last week, the dollar had lost more than 12% of its value against the pound, more than 11% of its value against the euro and more than 2% of its value against the yen. But that performance doesn't necessarily mean investors should rush into the CurrencyShares British Pound Sterling Trust, an exchange-traded vehicle that Rydex launched in June.

"Adding exposure with the pure-currency ETFs is foolish to the point of bordering on malpractice," said Russell Wild, founder of Global Portfolios, an advisory firm in Allentown, Pa. Currency swings are highly unpredictable, he said.

"To use the new currency ETFs to speculate on a continued fall of the dollar is just that - speculation - not investing," said Mr. Wild, author of Exchange-Traded Funds For Dummies (Wiley, 2007).

Of course, investors also could turn to one of the handful of actively managed mutual funds that provide exposure to currencies. One of the oldest such funds - the $383 million Franklin Templeton Hard Currency Fund launched in 1989 - turned in a respectable year-to-date return of 9.86% as of Dec. 6, placing it in the 12th percentile of its world bond fund category, according to Morningstar Inc. of Chicago. It's advised by Franklin Advisors Inc., a unit of Franklin Templeton Investments in San Mateo, Calif.

The fund's longer-term returns are less impressive, however.

It had a one-year return of 10.12%, placing it in the 21st

percentile of its category; a three-year annualized return of 5.36%, placing it in the 30th percentile of its category; a five-year annualized return of 9.78%, placing it in the 22nd percentile of its category; and a 10-year annualized return of 2.53%, placing it in the 98th percentile of its category.

There are much better ways to profit from a declining dollar, said Kirk Kinder, president of Picket Fence Financial LLC of Bel Air, Md.

"An adviser doesn't need to use currency instruments to benefit from the fall or rise of the dollar," he said. "Using foreign equity and bonds also provide additional return when the dollar declines."

For foreign-equity exposure, Mr. Kinder uses iShares ETFs from Barclays Global Investors of San Francisco and ETFs from the Vanguard Group Inc. of Malvern, Pa.

For foreign-bond exposure, he uses the "unhedged" $2.19 billion PIMCO Foreign Bond Fund and the $2.5 billion PIMCO Emerging Markets Bond Fund, both advised by Pacific Investment Management Co. LLC in Newport Beach, Calif.

Using funds that don't hedge their exposure to foreign currencies is important if investors want to take advantage of the dollar's decline, Mr. Kinder said.

There are other things investors can do, however, to take advantage of the decline of the dollar, said Don Martin, president of Mayflower Capital Inc. in Los Altos, Calif.

"[Treasury-inflation protected securities] could protect against a dollar decline, because a currency crash would create inflation which would result in increased compensation to TIPs owners," he said.

All are valid strategies for coping with a weak dollar.

But for the right investor, exchange-traded products that provide exposure to currencies also can be useful, said Jeff Tjornehoj, a Denver-based senior research analyst with Lipper Inc. of New York.

"If you don't have an informed opinion about a particular currency, then [using such products is] as good as throwing darts at a dartboard," he said.

But those that have a strong belief about a particular currency could benefit by getting the "pure" currency exposure an exchange-traded product offers that a foreign equity or bond fund just doesn't provide, Mr. Tjornehoj said.

"You can get currency exposure through traditional methods, but investing in a pure currency asset class give you a different set of returns," he said, possibly a smoother set of returns.

That's why Ann Miller, president of A. Miller Investment Advisors Inc. of Houston, said she uses the CurrencyShares Euro Currency Trust from Rydex. It serves to hedge her clients' portfolios, she said.

But Ms. Miller admitted to being leery of owning too much of it or any exchange-traded product that focuses on currencies. It's a small part of her clients' portfolios and probably will remain small.

Even though he doesn't own any such products, Tom Lydon, president of Global Trends Investments of Newport Beach, Calif., said he didn't see any problems with owning them. The only reason he hasn't put such products to use is that his clients are fully invested in the market, said Mr. Lydon, who also is a director at Rydex.

"If we had cash available at this point, I think we would consider a foreign currency fund," he said.

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