Investing in currencies remains a foreign concept to most investors for two major reasons. First of all, the average investor does not have the knowledge to determine how currencies fit into their portfolio and they do not know which currencies to own. The second factor has to do with how an investor will gain access to currencies. (For related reading, see Currency ETFs Simplify Forex Trades)
Whether you have ever invested in currencies in the past or not, I suggest you continue reading to determine if currency ETFs are a good fit for your portfolio. The obvious benefit of a currency ETF is diversification away from a traditional equity portfolio. They also could hedge a portfolio against situations such as a bear market or the demise of the U.S. dollar.
TUTORIAL: Forex Currencies
The Euro Versus the Dollar
The euro spiked to an 18-month high in May versus the U.S. dollar, only to begin a short-term downtrend on the back on concerns about the health of the Eurozone. By this week, the Rydex CurrencyShares Euro Trust ETF (NYSE:FXE) was trading at a fresh 4-month low. As the fear of more bailouts sweeps through Europe from Greece to Ireland - and newly added Italy - investors are have been dumping the European currency.
Even though the issues in the Eurozone may be real, so are the debt ceiling talks across the pond in the United States. The U.S. dollar has been in a decade-long downtrend even as the government has been promoting a strong dollar policy. The recent bounce in the U.S. dollar can be attributed to the fact the currency is the lesser of two evils. This is why the PowerShares DB US Dollar Bullish ETF (NYSE:UUP) is near a multi-month high.
The emerging market currencies have been holding up well as their underlying economies continue to grow at above average paces. This niche sector can add diversification to a portfolio and offer opportunities to gain exposure to emerging markets.
The WisdomTree Dreyfus Emerging Currency ETF (NYSE:CEW) invests in money markets in 12 different emerging market countries. The goal of CEW is to generate a return that reflects the money market rates in the foreign countries as well as the exchange rate with the United States. Some of the countries included in the ETF are South Africa, China, Mexico, Turkey and India. The current distribution yield is 3.6% and the expense ratio is 0.55%.
Brazil is included in CEW, however, if you want to focus solely on the Brazilian real there is the WisdomTree Dreyfus Brazilian Real ETF (NYSE:BZF). The ETF has been very strong over the last few years as the Brazilian currency continues to climb along with the country's economy and stock market. This is one of my favorite single-country currency ETFs.
The two foreign currencies that are the safe haven during rough times in the equity market are the Japanese Yen and Swiss Franc.
The Rydex CurrencyShares Japanese Yen ETF (NYSE:FXY) has been my "insurance" investment during rough times for equities. In 2008 when the S&P 500 fell 38%, FXY gained 20%. The ETF is currently near a new high and has been extremely strong over the last two weeks of volatility in the stock market.
The Rydex CurrencyShares Swiss Franc ETF (NYSE:FXF) has the best chart of all foreign currencies and is a few ticks from a new high. The ETF has been the leader in 2011, up 12% and beating its peers and the equity indexes. The currency has always been viewed as a safety play due to the country's strong economic background, low unemployment and low debt ratio.
The choice comes down to which currency ETF, if any, you should own. Unfortunately, all investors are different and that decision needs to be made by you or your advisor. For our clients, we look to create a mix of currency ETFs depending on the current market environment. The safe havens appear to be the most attractive at this time.
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!