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Playing A Falling Dollar With Other Currencies

As the U.S. dollar continues to show signs of weakness and the U.S. economy struggles to overcome the powerful forces of high unemployment, investors have been looking at ways to hedge their exposure to the dollar and the answer might lie in other currencies.

Traditionally speaking, investors have shunned away from currencies due to their volatility and have turned to other areas like bonds, commodities and foreign markets to hedge their exposure to the dollar.  When it comes to commodities, most turn to gold (Ways to Play Gold) and crude oil to protect themselves since they are traded in dollars making them cheaper and more attractive to foreign investors.  As for foreign markets, most have turned to emerging and frontier markets (More on emerging markets) as these nations are growing at exponential rates and are putting their footprint on the global economy.

The U.S. dollar has fallen as a result of heavy borrowing and massive  “money printing” by the federal government in an attempt to fund programs to bolster the crippled economy and many think that it will continue to do so, keeping the dollar at depressed levels.  To capitalize on this situation through the use of foreign currencies, one can consider exchange traded products offered by Rydex Funds, WisdomTree and Invesco PowerShares.

The funds provided by Rydex are structured as grantor trusts with expense ratios of 0.4% and hold foreign currencies in overseas interest-bearing accounts where their appreciation or depreciation is directly determined by the movement in the relative currency versus the U.S. dollar.  They are primarily used to gain single county currency exposure.  Common Rydex funds include the CurrencyShares Australian Dollar Trust (FXA) and the CurrencyShares Euro Trust (FXE).

For a more diversified approach, Wisdom Tree offers the WisdomTree Dreyfus Emerging Currency Fund (CEW) which enables one to gain exposure to eleven different emerging market currencies, including India, South Africa, China, Brazil, Mexico, South Korea, Chile, Poland, Israel, Turkey and Taiwan.  The fund carries an expense ratio of 0.55% and aims to offer investors current income reflective of foreign money market rates available to U.S. investors.

PowerShares offers a unique approach to gaining exposure to foreign currencies through its PowerShares DB G10 Currency Harvest Fund (DBV) which takes long positions in futures contracts in the three G10 currencies with the highest interest rates while simultaneously taking short positions in futures contracts in the three G10 currencies with the lowest interest rates.  DBV carries an expense ratio of 0.75%

The above mentioned ETFs are just a few of the many currency ETFs available to investors.

India and Its ETFs

When investors want to diversify and gain international exposure, many turn to Asia and in particular, China. However, neighboring India may be just as attractive. 

Some key items working in India’s favor include an expected growth rate of 6% for 2009 – driven primarily by public spending, an increase in auto and infrastructure demand, an increase in industrial production and strong equity markets.  In addition, business confidence is rising and the country’s financial markets, in terms of IPOs and debt origination, are coming back to life.

Another factor that makes India attractive is the importance that President Obama is placing on building a long- lasting relationship between India and the United States.  The United States is India’s largest trading partner and President Obama believes that building a strong relationship with the South Asian country will help re-build the U.S. economy and create jobs.

Lastly, factors such as capital flows, domestic demand, portfolio flows and a strong savings rate have India in a good position to continue moving forward.  A combination of the aforementioned has led some to believe that India will grow even faster, at a rate of 7% in 2010.

Things going against the nation are the inherent risks and volatility involved with investing in an emerging market, a weak monsoon season which has hindered agricultural output and a decline in exports.

Gaining access to the South Asian country is relatively easy through the following ETFs:

• WisdomTree India Earnings Fund (EPI), which carries an expense ratio of 0.88 % and is based on an earnings-weighted index with 125 holdings.
• iPath MSCI India Index (INP), which carries an expense ratio of 0.89% and is an exchange traded note based on the MSCI India Total Return Index, which has 59 constituents.
• iShares S&P India Nifty 50 Index Fund (INDY), which carries an expense ratio of 0.89% and will invest in securities and depositary receipts of India’s 50 largest companies by market capitalization.

Additionally, to further diversify exposure to India, there are a couple of new ETFs in the pipeline.  The first is from Van Eck Global, which has registered a new ETF that will enable investors to gain exposure to small-cap stocks in India and will seek to replicate the performance of the Market Vectors India Small-Cap Index.  The second is from Emerging Global Shares, who is planning to launch the Dow Jones Emerging Markets Technology Titans Index Fund (EWT), which will have a 46% country weighting allocated to India.

Fixed Income ETFs Are Red Hot

Innovation continues to loom amongst fixed income exchange traded funds as ETF providers launch new products and attract assets.  The influx of assets into fixed income ETFs has been so great that a research report, conducted by Pali Research, indicates that assets in fixed income ETFs have jumped by 67% since the end of 2008 (more on ETF innovation). 

Most recently, ETF provider Vanguard has added to the plethora of fixed income ETFs by launching seven new bond ETFs.  These ETFs all carry an expense ratio of 0.15% and seek to track a market-weighted bond index with a dollar weighted average maturity.  They include:

• Vanguard Short-Term Government Bond Index Fund (NASDAQ: VGSH) which tracks the U.S. 1-3 Year Government Float Adjusted Index and seeks to track the performance of a market-weighted government bond index with a short-term dollar-weighted average maturity.
• Vanguard Intermediate-Term Government Bond Index Fund (NASDAQ: VGIT) which tracks the U.S. 3-10 Year Government Float Adjusted Index and seeks to track the performance of a market-weighted government bond index with an intermediate-term dollar-weighted average maturity.
• Vanguard Long-Term Government Bond Index Fund (NASDAQ: VGLT) which tracks the U.S. Long Government Float Adjusted Index and seeks to track the performance of a market-weighted government bond index with a long-term dollar-weighted average maturity.
• Vanguard Short-Term Corporate Bond Index Fund (NASDAQ: VCSH) which tracks the U.S. 1-5 Year Corporate Index and seeks to track the performance of a market-weighted corporate bond index with a short-term dollar-weighted average maturity.
• Vanguard Intermediate-Term Corporate Bond Index Fund (NASDAQ: VCIT) which tracks the U.S. 5-10 Year Corporate Index and seeks to track the performance of a market-weighted corporate bond index with an intermediate-term dollar-weighted average maturity.
• Vanguard Long-Term Corporate Bond Index Fund (NASDAQ: VCLT) which tracks the U.S. Long Corporate Index and seeks to track the performance of a market-weighted corporate bond index with a long-term dollar-weighted average maturity.
• Vanguard Mortgage-Backed Securities Index Fund (NASDAQ: VMBS) which tracks the U.S. MBS Float Adjusted Index and seeks to track the performance of a market-weighted U.S mortgage-backed securities index with an intermediate-term dollar-weighted average maturity.

Additionally, bond giant PIMCO recently launched a new product, the PIMCO Enhanced Short Maturity Strategy Fund (MINT), which is an actively managed short-term bond ETF that aims to preserve capital while also looking to offer more attractive yields than those earned from traditional money market funds.

ETF providers continue to innovate and introduce new products to market and the industry as a whole continues to grow and put pressure on mutual funds.

New Way To Play Gold

As gold prices continue to rise on a weak dollar and fears of inflation, ETF provider Market Vectors introduced a new way to play the commodity.

The new ETF, the Market Vectors Junior Gold Miners ETF (GDXJ), is constructed to track a basket of smaller gold mining companies.  The Market Vectors Junior Gold Miners Index, which GDXJ seeks to replicate, provides global exposure to small and mid-capitalization companies that generate at least 50% of their revenue from gold and silver mining.  A requirement for companies that are included in the index is that they must hold real property that has the potential to produce at least 50% of the company’s revenue from gold or silver mining when developed, or primarily invest in gold or silver. 

As of now, the top holdings in the fund include Coeur d’ Alene Mines (CDE), New Gold (NGD) and Silver Standard Resources (SSRI).  These are small mining firms, and some, like Silver Standard Resources, are still in the development stage which increases the risks involved with investing in GDXJ.  Additionally, lower trading volume and liquidity issues will likely add to the volatility of this new ETF. 

In and of itself, GDXJ was launched at a good time by an ETF provider that is no stranger to the market.  After all, the Market Vectors Gold Miners ETF (GDX), which tracks much larger gold mining companies, has been a success and boasts nearly $5 billion in assets.

What To Look For In Emerging Market ETFs

As the ETF landscape continues to change and new product innovation remains robust, iShares is looking to further expand its offerings of emerging market ETFs.

The leading ETF provider is expected to introduce two new ETFs:  the iShares MSCI Emerging Markets Financials Sector Index Fund and the iShares MSCI Emerging Markets Materials Sector Index Fund.  One reason that iShares has decided to introduce these new ETFs is the appeal of emerging markets.  In October 2009, net inflows into the iShares MSCI Emerging Markets Index (EEM) and the Vanguard MSCI Emerging Markets ETF (VWO), the two most actively traded and largest emerging market ETFs, accounted for 45% of all net inflows into exchange traded funds.

There is no doubt that international ETFs are becoming more popular and can offer great diversification benefits to a portfolio, but before considering adding more than one, it is equally important to consider concentration and overlap.  

On one end of the spectrum are the broad-based ETFs, like EEM, which diversify assets over a vast array of emerging market equities.  EEM’s top three country holdings are Brazil, China and Taiwan, with 16.2%, 15.7% and 10.6% allocations respectively.  On the other end of the spectrum are the concentrated funds which give exposure purely to one country, like the iShares MSCI Turkey ETF (TUR).  These two ETFs enable one to gain exposure to emerging markets, but in completely different ways and with completely different risk profiles.

A second factor to consider is the holdings of the ETF.  In many emerging market ETFs, single companies can dominate performance because of their relative size and the fact that the ETF uses market capitalization or modified market capitalization to allocate assets.  An example of this can be seen through the iPath MSCI India Index ETN (INP), which has 59 holdings and allocates nearly 23.5% to two companies.  A well-diversified ETF will allocate no more than 10% of its assets to its top holding. 

Thirdly, it is equally important to be mindful of the underlying sector allocation of an emerging market ETF.   Take TUR, for example – the ETF holds 80 different stocks, however it allocates more than half of its asset base to the financial sector.  Another example is the Market Vectors Russia (RSX) which holds 36 different stocks but allocates more than 50% of its assets to the oil, gas and energy sector.

It is important to know what an ETF holds and tracks before utilizing it to build a well-balanced portfolio.  You don’t always get what you think you are getting.