By Murray Coleman and Matthew Hougan
Van Eck has joined the double-leveraged and double-short exchange-traded notes market with the launch on Wednesday of euro-focused portfolios.
In launching the notes, Van Eck and Morgan Stanley are taking a page out of the ProShares playbook. ProShares, of course, has attracted more than $17 billion in assets to its stable of leveraged and inverse exchange-traded funds. Rydex, Deutsche Bank and Direxion have all jumped into the inverse/leveraged scramble as well.
Meanwhile, Rydex has attracted nearly $1 billion into its Euro Currency Trust (NYSEARCA:FXE), an ETF that provides one-for-one exposure to the dollar.
So if leverage is hot... and the euro is hot... how can a leveraged euro note miss?
Both ETNs are based on total return indexes, which means that the ETNs' value will include daily interest based on overnight federal funds open rates. Interest will be incorporated into the value of the notes, rather than paid out in separate payments; investors will still have to pay taxes on this "virtual income" each year.
The index for URR will finance its leveraged currency exposure by using forward contracts in U.S. dollars. The overnight exchange rates on euros can differ dramatically from those on U.S. dollars in terms of forward contracts compared to spot prices. "Consequently, the level of the Index will be affected by differences between euro interest rates and U.S. dollar interest rates in addition to any changes in the spot euro/U.S. dollar exchange rate," according to the ETN's prospectus.
Minus the interest rate differential and the total return accrual factors, if the euro strengthens by 1% relative to the U.S. dollar, the index is designed to increase by 2%. Conversely, if the euro weakens by 1% relative to the U.S. dollar, the index level should decrease by 2%.
The Double Long Euro Index was developed by Morgan Stanley and is calculated, maintained and published by Standard & Poor's Corp. It has a base date of January 2, 1999.
Through April 30, the index was up 16.13% in 2008. In the past five years, the Double Long Euro Index had returned 16.06%, according to Van Eck. That's not counting annual expense ratios. On both URR and DRR, those are expected to wind up around 0.65%.
Entering March, DRR's index wasn't doing as well. It had returned -12.86%, while over the past five years through April 30, it had lost 10.62% on an annualized basis.
The index for DRR is designed to reflect borrowing euros and selling them short for U.S. dollars, investing the U.S. dollars for one day and converting them back into euros to repay the lending activity.