Analyste de Boston

Getting a Handle on Currency ETFs

In a diversified portfolio >$100k, currencies can be considered a "fixed income alternative" - if you understand the risks are different, you monitor your investments, etc.

For most IRA investors, prudent allocation is probably < 10% to all currency plays. In my Model (7% allocation) that's a YTD nav +0.54% vs. -0.34% for the AGG (which has a higher yield, however.) You can see these gains quickly erode in periods of crisis/deleveraging: definite NOT SUITABLE as 'buy-&-hold' investments!

I prefer foreign bond funds (like WIP & PCY) for more significant and longer term Fxd Inc allocations.

Rising Interest in Currency Funds

Oh, I don't hit "Reply" because I find long, repeat text a huge nuisance to scan. Sorry if this led to your confusion about my 2nd Reply. Thanks!

Rising Interest in Currency Funds

Richard, I was responding to RiskReturnOptimizer in my second reply. (You replied before me, out-of-sync.)

I have the greatest respect for your work, and my first Reply was simply an Addendum. I think we're all on the same page, but I do play Devil's Advocate when I see so many articles chasing a hot sector. This one definitely needs caveats.

Someone has to underscore the currency risks, especially when those ETFs are flying and getting "rising interest" no?

Rising Interest in Currency Funds

I'm reluctant to take fund companies promotional claims at face value. Does your purported long term average annual return (before inception) include ALL costs & taxes?

I also wonder why you'd compare DBV to the SPY, much less consider it a "core holding" (>15%?) If you're an aggressive investor, you also understand that most people don't intentionally share that risk-tolerance.

Considering the NAV alone, DBV lost -26% since 10/9/07, the onset of the Great Bear Mkt. Isn't its performance closer to a junk bond fund? Maybe that's a way to consider suitability for a client or investor : "Would you feel comfortable investing in junk bonds?"

As a "core holding," I very much doubt that's appropriate for most investors.

Rising Interest in Currency Funds

I jumped on the currency ETF bandwagon relatively early, back in 2006. My experience hasn't been bad, but CAVEAT EMPTOR! with currency funds.

Most investors don't have assets to reasonably invest in spot, and futures contracts are likewise too esoteric for the mutual fund crowd. (Be reasonable.) I'll also exclude large institutional hedgers, bigger clients >$5mln investable assets, gamblers and day-traders from what follows, my own opinion if/how these currency ETF/ETNs suit most retail investors.

For diversified IRA accts and the portfolios of small shop investment advisors, the forex allocation is probably just a TREND TRADE. Currency plays are a much riskier alternative within fixed income: a 3-15% allocation might be suitable for some investors but probably NOT "most." Why?

Consider the RISK carefully : from 7/17/08-10/27/08, FXE lost -21%, FXA lost -38% FXS lost -25%, BZF lost -28%, etc. A second wave of global deleveraging will almost certainly entail similar losses. Those anticipating big equity declines tomorrow shouldn't overweight forex now: once burned, twice shy. Have we learned anything?

These aren't set-it-forget-it investments, people! Given the OLD story of the Dollar's purported weakness, I will continue to use a couple of currency plays going forward, but in 2008 the gain on a prudent allocation was only about 100-150bps over FDRXX (15%, with trading exits, entries and switches.) If 2009-2010 proves so volatile as last year, expect losses with many currency ETFs.

Final assessment:
Given the fractional allocation and constraints on resources (honestly factoring time, due-diligence, understanding & tracking the forex mkts, opportunity costs, etc.) most advisors & long-term investors will likely seek greater alpha for smaller accts elsewhere.