With big swings in equity and bond prices becoming the norm, many investors have turned to alternatives to help smooth-out their rides. Realizing that a standard portfolio may not be enough to make to it the finish line, many have taking a page out of institutional investors' playbooks. Asset classes such as commodities and managed futures are creeping into more and more portfolios. Funds like the ProShares Credit Suisse 130/30 ETF (ARCA:CSM) have gained in popularity as investors have sought exposure. One such unconventional asset class, despite trading nearly $4 trillion a day, is often ignored by the retail set. However, this asset class could be exactly what investors need in terms of finding uncorrelated options for their portfolios.
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A Focus on Currency
The global currency sector remains the world's largest marketplace, with trillions of dollars' worth of notes exchanging hands every day. Yet, most retail investors have zero direct exposure to the asset class aside from holding foreign stocks and bonds. Current assets in currency exchange-traded funds (ETFs) sit at just $5 billion. That accounts for just 0.4% of total ETF assets of $1.2 trillion. However, investors may want to make themselves more familiar with the sector.
SEE: 6 Popular ETF Types For Your Portfolio
First, the asset class can help with eliminating currency risks and can help deliver better returns on foreign stocks and bonds. For example, from the depths of the Great Recession in March 2009 through March of 2010, European equities rose more than 50%. However, a plunge in the euro against the U.S. dollar dulled that hefty gain for U.S. portfolios. A vehicle like the PowerShares DB US Dollar Index (ARCA:UUP) would hedge against that risk and let the equities performance speak for itself.
Secondly, investors can increase their overall diversification. Currencies have low correlations versus more traditional securities. According to Merk Investments, those correlations range from just 0.42 to -0.13. Currencies can be used to provide the zig when domestic stocks, bonds and other money market instruments zag. In addition, they exhibit low parallels compared to other "alternative" asset classes such as commodities and gold.
Finally, currencies can be added to a portfolio as a growth element. Currency movements generally tend to correlate with economic growth and countries that run trade surpluses eventually see their currency rise in value. Therefore, buying the currencies of countries with robust growth prospects can be a successful long-term strategy.
SEE: 10 Tips For The Successful Long-Term Investor
Taking the FOREX Plunge
While opening an account at a brokerage like FXCM (NYSE:FXCM) can be used to gain currency exposure, the ETF boom might be more suitable for most investors. There are nearly 30 ETFs tracking a variety of currencies and strategies. For example, CurrencyShares Euro Trust (ARCA:FXE) can be used to make a direct bet on a rising euro versus the U.S. dollar.
With the variance of interest rates around the world, investors can profit by using a carry trade strategy. Essentially, an investor borrows money in a low-interest-rate currency and then invests the proceeds into higher yielding notes. Research done by ratings agency Morningstar (Nasdaq:MORN) shows that under most market conditions the strategy can produce equity like returns with much lower volatility. The PowerShares DB G10 Currency Harvest ETF (ARCA:DBV) goes long or short on various developed market currencies including dollars, euros, yen, francs and pounds, based on underlying interest rates. Likewise, the iPath Optimized Currency Carry ETN (ARCA:ICI) can be used to add currency arbitrage to portfolio.
SEE: Trading The Odds With Arbitrage
As one of the major contributors to future economic growth, Asia has seen its currencies appreciate over the last few years. With analysts predicting that trend will continue, the iPath GEMS Asia-8 ETN (ARCA:AYT) could be a great buy. The exchange traded note follows a basket of eight Asian currencies including the Indonesian rupiah, Thai bhat, Chinese yuan and Malaysian ringgit. Likewise, Asia's industrialization has benefited the resource-rich nations that supply the continent with raw materials. Funds like the WisdomTree Dreyfus Commodity Currency (ARCA:CCX) and CurrencyShares Australian Dollar Trust (ARCA:FXA) offer exposure in this area.
The Bottom Line
For investors looking for alternatives for their portfolios, currency remains a compelling addition. The under-utilized asset class comes with a host of benefits outside the world of stocks and bonds. By using ETFs, investors have the ability to add currency baskets such as the WisdomTree Dreyfus Emerging Currency (ARCA:CEW) to their portfolios.
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At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.
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