Chinese Currency ETFs: Waking Up to a Yuan Yawner

| About: WisdomTree Chinese (CYB)

By Matt Hougan

Investors in the WisdomTree Dreyfus Chinese Yuan ETF (NYSEARCA:CYB) got everything they could have wished for over the weekend, and what did it net them? Bupkis.

The big news driving markets today is that China has pledged to “enhance” the flexibility of its currency exchange rate, after years of maintaining an artificially low peg against the U.S. dollar. This is the moment that investors in CYB have been waiting for. The fund, after all, is designed to give exposure to Chinese currency rates. Investors have eaten it up: As of the close on Friday, CYB had $723 million in assets.

As I wrote about recently in a guest column for RealMoney, investors figured this was a “no lose” bet. Everyone agreed that the yuan was undervalued against the U.S. dollar. Therefore, there was essentially no downside beyond the expense ratio if you bought CYB. Meanwhile, everyone agreed that China might allow the yuan to appreciate, which would benefit CYB holders.

Now China has done just that, and CYB is trading up … a whopping 0.66 percent?

Forgive me if I’m underwhelmed.

You’ve got $723 million paying a combined $3.3 million in annual expenses and they get a 0.66 percent return when everything goes right?

But wait—it gets worse.

CYB is actually down about 1 percent in the past year, for two important reasons. First, expenses weigh down returns. Second, CYB doesn’t invest in physical currency, it invests in currency futures. Those futures will price in expectations of future currency movements before they happen. A year ago, they were pricing in a significant uptick in the yuan-dollar exchange rate: something along the lines of 3 percent. But when the euro imploded, the pressure on China to revalue its currency decreased, and that deflated the yuan’s premium in the futures market. Today, despite China’s newfound willingness to revalue, we’re looking at expectations of a moderate rise of 1 percent or so.

CYB, and its smaller competitor, the Market Vectors Chinese Renminbi/USD ETN (NYSEARCA:CNY), are fine products. As long as you understand that they deliver exposure to currency futures, not physical currency, they do exactly what they say they do.

But investors who think the Chinese yuan is a thrilling investment need to realize that any changes in the currency peg will be gradual. And weighing the speed of those changes against the funds’ expense ratios is key.

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