Currency ETFs: Consider the Commissions

There are many currency ETFs out there covering not only major pairs such as the Euro, British Pound, Japanese Yen and Swiss Frank, but other exotic currencies such as the Chinese Yuan and the Brazilian Real. Currency ETFs provide investors with instruments that trade like stocks and could be bought, sold and sold short at any time that the stock market is open. Several companies offer ETFs on currencies and those include Barclays Bank, Deutsche Bank, Morgan Stanley, Wisdom Tree and Rydex.

In the process, these companies have raised almost 4.6 billion dollars for exchange traded funds or notes which simply hold underlying currencies. I didn’t include other ETFs that used strategies such as doubling the exposure to a specific currency, using a yield harvesting approach or ETFs tracking the US Dollar Index.

Before you rush into currency ETFs, however, there are the annual fees of .35% to 0.45 % for you to consider.

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In addition to that, because currency ETFs trade just like individual stocks, you have to pay a commission to enter and exit the fund.

Thus, on a $1000 investment in a currency ETF, you underperform the underlying by the amount of management fee, 0.4% plus a commission to buy the ETF, which will vary from $4 at Sharebuilder to $7 at Scottrade.
If you must buy and hold or simply trade a currency, why don’t you simply open a forex account at a well known broker such as Oanda, and then you won’t pay any management or stock trading fees. In addition to that, Oanda will add the interest to your account on a daily basis, which will allow for a faster compounding of the principal.

The only reason why one would hold currency ETFs as opposed to opening an account with a forex broker is if their 401K plan only offers a currency ETF and the investor must have some foreign currency exposure in a non taxable account.
To summarize, whenever you think about buying a new investment product, stop for a second and think how you can save money. Always check for alternatives whenever there are fees that you can avoid. If investors listen to this message, they will save approximately 19 million dollars annually just from avoiding annual management fees. How much could be saved from avoiding trading commissions could probably end up in millions of dollars as well.

[See here for list of Currency ETFs and ETNs]

Comments

[Ray Hendon:]

For accounts that allow free ETF trades, see: seekingalpha.com/artic...

2008 Aug 26 02:50 PM

[Dividend Gr...:]

Ray,

Thanks for your input. Commission free brokerages like Zecco and BAC are something I should have mentioned.
Another problem however is that you are still paying 0.35%-.55% annually which would lead to you undeperforming the underlying over a 10, 20 year period. So if you really want to invest in currencies, wouldn't it be easier to just open a forex account?

Just my 2 cents

2008 Aug 26 03:56 PM

[Ray Hendon:]

I can think of several important reasons to favor the ETF or ETN format to that of a currency broker. First, an exchange traded product does not require the buyer to short a currency. While you are using dollars, for example, you don't have to short them. Shorting half of a pair doubles the risk for an investor, and for the carry trade, the buyer prefers that the two currencies remain constant so the interest earnings can be fully enjoyed.

Secondly, on pairs that are not the big six, the spread with a broker is huge. Try buying the Mexican peso (which you have to buy paired with a shorted dollar) from a broker. The spreads are over a hundred times that of the $/Euro. Also, most of the forex trading platforms I checked out do not have more than 30 or 40 pairs, and fully a third of the pairs are denominated in either dollars, euros or yen.

Thirdly, if one opens a forex account the account must be funded. That means selling some of your other assets and paying taxes on the gains--which may be inconvenient at the time. This is especially bothersome if you have your money in a tax protected account. In that case, you must jump through a number of hoops just to get your hands on your money, and you may lose some of the principle because of early withdrawal.

I am not putting down forex trading--although I do not engage in it myself. I am advocating a less frenetic way of investing in currencies, either carry trade or value investing, without having to devote your entire life to learning forex trading--and you must admit it is a lot to learn (assuming you want to be successful--and even then, the odds are against you).

Finally, you can get various bundles of currencies in exchange traded products, which would be difficult to duplicate in a forex account. Diversity is much easier to achieve in the ETF, ETN products. There are some exceptions, I see lately, coming from the forex brokers. I am glad to see them begin offering bundles or other strategy accounts that make forex investing more accessible to ordinary investors.

For traders I can see the advantage of a forex account. But for a more casual investor, who still wants to participate in the benefits that currencies bring to a portfolio, I think an exchange traded product is a good way to proceed. Of course, this is just an opinion, and I may be entirely wrong.

Best wishes,

Ray

2008 Aug 26 08:28 PM

[TomF75:]

Thanks for the info. I'm looking at various ways to diversify my cash out of the American Peso, and didn't think one could open a FOREX account w/o the desire to trade the currency on a regular basis.

2008 Aug 26 11:39 PM

[ikkyu:]

Greetings,

I agree with the original poster on these costs being absurd. Any medium to long term forex strategy is going to be better accomplished with a forex broker. ETF's are a primitive way to get such exposure.

I am not sure where Ray is getting his quotes from. I show a spread of around .007% for EUR/USD and .039% for USD/MXN. That is more like 5.6x than 100x, my friend.

For a one year holding period costs are 57x cheaper using the broker OANDA for EUR/USD than the ETF FXE. That is not counting the bid/ask spread on the ETF or commissions, which could jack this up considerably. You have no further costs after that (outside of interest on a negative carry) no matter if you hold for years. So there is virtually no comparison cost wise.

See spreads and carry interest for Oanda here:
www.xrof.com/index.htm...

These ETFs are a scam. This is the cheapest market to trade in the world! Hell, SPY has what like .17% expense ratio?

Also you didn't mention the tax advantages. If you document yourself as a professional trader, you get 60/40 (LT/ST capital gains) like for futures trading.

Here is another article similar to yours:

www.thefinancialwhiz.c.../

I like Ray, he seems cool and quite thoughtful, but ETFs are blunt, expensive ways to trade currencies not matter how long your holding period.

Best wishes,

john

2008 Aug 27 11:17 PM

[Ray Hendon:]

John: My experience with mexican peso, using CitiTrade was different than yours. The spread was over 100 pips--I was selling the us/mx short. And, it took hours after the order was made to get it executed.

Also, there is the rather important issue of leverage. The investors I work with would be lost handling the complexities of leverage and shorting pairs. For the type of investing they do with currencies, ETFs are ok.

I don't think traders would ever buy ETFs. It's not in their interest--I agree with you on that. But I like them for the type of investing I do. Bundles for diversity, for example.

Best wishes to you , too. And make a bundle.

Ray

2008 Aug 28 02:33 AM

[ikkyu:]

Greeting Ray,

Fair enough my friend.... different strokes and all. Funds like DBV and JEM may be useful, if expensive.

If there is a bundle to be made, carry trading is likely the best way to do it IMHO.

Best wishes and thanks for your opinion.

john

2008 Aug 28 06:58 AM

[zcream:]

Hi Ikkyu. I followed your comments on oanda. I was looking at the multi-currency sandwich carry trade mentioned by Gary and Jyske Bank over the past years. However, they talk of borrowing short and buying long.
How can you do that with oanda ? You can sell a future - and you are borrowing short. Then what ? How do you buy a long term denominated bond ? I'm looking at the USD ISK carry trade in a couple of months..

2008 Sep 30 08:07 AM