Choosing A Currency ETF: Why We Went With DBV

 |  Includes: DBV, GCF
by: Keith Lenger

We added a currency position to one of our equity portfolios mid-year last year, as we think they should be required of any portfolio seeking diversification. After studying the various offerings, we felt that only one managed currency portfolio fit the bill.

Prompting this post was an article by Shefali Anand and Craig Karmin of the Wall Street Journal, Betting on the Buck ($). In the article they cite 14 different currency funds launched in the past year. They describe mostly long or short currency funds. They hit upon the gems in the second and third to last paragraphs of the article:

Some other currency offerings aim to mimic a popular yet risky strategy called the carry trade, which tries to profit from the difference between interest rates of different countries. These strategies can quickly get complex, but basically involve investing in various futures in countries with high interest rates, while selling short futures in countries where rates are low.

Carry trades can be particularly risky because they can unwind rapidly under certain circumstances.

Two products that follow this approach are PowerShares DB G10 Currency Harvest Fund and Global Income & Currency Fund (NYSE:GCF), a closed-end fund subadvised by Nuveen Investments. Nuveen’s Multi-Currency Short-Term Government Income Fund, a closed-end fund that buys short-term bonds of foreign countries, has garnered $800 million and began trading in April.

For our portfolios we selected PowerShares DB G10 Currency Harvest Fund (NYSEARCA:DBV) for a few reasons. It is our belief that betting against one particular currency move in either direction, although potentially extremely profitable, is too risky. Currencies have a tendency to change very quickly and in the short term are influenced by more than just economic fundamentals. This leads us to wipe out all long and short single currency funds.

Case in point: the bearish bet Warren Buffett made against the dollar only to unwind the position with a loss. Year to date 2007 the dollar did lose value, but only after surprising almost everyone to the upside last year.

DBV goes long the top 3 G10 currencies with the highest interest rates and shorts the lowest 3 interest rates. In effect they have diversified away from playing one single currency. They reevaluate the currency positions in a disciplined schedule, which is laid out in the prospective. In short, they have a process based on long-term economic cycles. This disciplined approach has delivered outperformance over 10 years vs. the S&P 500 (see fact sheet - .pdf) with less volatility and correlation.

We think this type of managed ETF could serve a long term small percentage holding to any portfolio seeking diversification. It is a perfect fit to those seeking additional international exposure.

Disclosure: Author's fund is long DBV

DBV 1-yr chart: