Currency ETFs: Some Pluses and Minuses

Let it never be said that there are not enough currency vehicles available to mainstream individual investors. Active currency traders have had access to the currency markets via various currency brokers and future contracts. Most advisors recommend that investors have some portion of their portfolio overseas with the currency exposure unhedged. Now that there are a cornucopia of new vehicles available, the real question is how investors should manage, or not, their foreign currency exposure?

Katie Benner at TheStreet.com has a look at the slew of “sophisticated” ETF vehicles that have recently come to market, including the currency ETFs. We have been skeptical of the ETF providers in that they have changed the nature of the ETF value proposition. Apparently we have some support for that:

"Originally, ETFs came out and built on the premise behind indexing — that if you have a broad portfolio and keep expenses low, the odds of beating the typical active manager are pretty good,” says Morris. “But the landscape has changed over the past couple of years and ETF providers have sliced and diced the market into narrower and narrower segments, which is very different from the original intent and the goal of indexing."

While these products are targeted towards sophisticated individual investors and professionals, the risk is that they are poorly understood or misused by individual investors.

Arijit Dutta at Morningstar.com does not specifically address the new currency ETFs, but given this quote we think that they would not be high on the list for individual investors:

Because currency movements are notoriously hard to predict, we would also advise that investors avoid big bets on the direction of the dollar. Yet we also think it’s advisable to have at least a small amount of non-dollar currency exposure in your portfolio. You can look at it as buying some insurance against the possibility of a sharp decline in the dollar. In the long run, foreign-currency exposure also tends to diversify a portfolio nicely.

Given this thinking exposure to international equity, fixed income and cash equivalents would be sufficient to provide most investors with enough non-dollar exposure to suffice.

Speaking of the new currency ETFs, Roger Nusbaum believes if these six new funds are reasonably successful we can probably expect new ones down the road. Roger is favorably inclined towards the Currency Shares Swedish Krona Trust (FXS). See also John Spence's overview in MarketWatch.

Adam Warner is all in favor of more currency vehicles, but wants multiply-listed options listed on each of them.

We are all for letting the market sort out the slew of new ETFs. For those investors with strong views on the relative merits of these currencies, these vehicles provide an easier route to currency exposure. We are however skeptical that these vehicles will be a wise choice for the majority of investors.