What is a Euro ETF
A euro ETF is an exchange-traded fund that invests in the euro, either directly or through euro-denominated short-term debt. Euro ETFs are often established as currency trusts or grantor trusts, which means that stakeholders have a claim to a specific amount of euros per share. Currency ETFs intend to track the performance of a single currency in the foreign exchange market against the U.S. dollar or a basket of currencies. Previously, these markets were only accessible to professional traders; however, the rise of exchange-traded funds over the past decade has opened the foreign exchange market to additional segments of investors.
An Introduction To Exchange-Traded Funds (ETFs)
BREAKING DOWN Euro ETF
A euro ETF is an investment in one of the world's most liquid currencies, making ETFs attractive for investors looking to capitalize on the currency's appreciation without having to access the futures or foreign exchange markets. In addition, euro ETFs can be shorted, as a bet that the currency will fall versus the dollar.
Essentially, a currency ETF investment is a speculative trade on spot exchange rates, which may be the most fundamental part of an investment in currency funds. This means investors place a bet on one of two outcomes: the core currency performs well or the counter currency declines. The investor will always take a long position on a currency relative to being short another one. For example, the CurrencyShares Euro Trust (FXE) will increase when the euro performs well or when the U.S. dollar falls. Besides benefitting from the currency appreciation that occurs, investors receive interest rate payments for holding a currency over time.
Euro ETFs and Currency Hedges
Trading currency ETFs can help improve portfolio returns, but there are risks to investment in the foreign exchange market that can have significant effects on total returns. For one, ongoing macroeconomic events can affect currency performance, including interest rate movements, various global economic conditions and geopolitics. For example, a sluggish economic release, volatile political move or interest rate hike could cause multiple exchange rate fluctuations. Sometimes a natural disaster in an emerging country can negatively affect the currency market as well, though that occurs independently of trading behavior.
For investors, currency-hedged ETFs can be a way for investors to help mitigate the effects of those fluctuations across their portfolio. If the U.S. dollar were to appreciate versus the euro, then an unhedged ETF would suffer currency losses that offset any gains in the euro. However, a currency-hedged ETF, which essentially works as a futures contract on currencies allows investors to lock in the price of a currency ahead of any potential fluctuations.