Pimco recently made a splash in the currency world after launching the first purely actively managed currency ETF on Feb. 12.
The Pimco Foreign Currency Strategy ETF (FORX) provides exposure to a basket of currencies from developed as well as emerging markets that the managers think are poised to appreciate against the dollar over the long term.
I refer to FORX as the first “purely active” currency ETF because the active strategies behind the handful of existing currency basket funds from WisdomTree are quite different from what most might traditionally consider being active management.
In both the WisdomTree Emerging Markets Fund (CEW) and WisdomTree Commodity Currency Fund (CCX), underlying currencies are mostly fixed and rebalanced quarterly to keep them equally weighted. I like to think of this type of strategy as “semi-active.”
On that front, the WisdomTree funds certainly follow a more disciplined selection and weighting strategy—almost like an index fund—that many investors might actually prefer.
Comparatively, FORX has a go-anywhere, choose-any-currency-with-any-weighting strategy. This can also mean the portfolio of currencies can look very different depending on the day or specific macro environment. By the way, holdings of any one currency are capped at 20 percent.
I recently wrote about why active management can make sense in fixed-income and certain niche themes, like frontier markets. I also think active strategies are increasingly making sense in the currency space as well.
In response to the financial crisis of 2008, central bank interventions through quantitative easing programs are increasingly influencing the currency markets. As such, being selective in choosing the right currencies is becoming essential.
Switzerland and Japan are just two examples of how central bank actions can change the outlook for a currency overnight, though the yen’s plunge has been based mostly on strong political rhetoric thus far as opposed to bona fide policy moves. The European debt crisis and the European Central Bank’s actions are also heavily influencing the movements in the euro.
Noticeably absent from FORX is any euro exposure as of Feb. 13. Instead, FORX loads up on developed-country currencies like the Norwegian krone, the Swedish krone and the Canadian dollar.
Even more obvious is the fund’s heavy exposure to emerging market currencies like the Russian ruble and Mexican peso—a more than 9 percent weighting in each. Other developing-country currencies rounding out the top 10 holdings are the Brazilian real, the Chinese renminbi and the South African rand.
FORX’s strategy looks very different from the strategy implemented by Axel Merk in his actively managed Merk Hard Currency Fund (MERKX), which currently has $584 million in assets under management.
I mention MERKX here because Merk filed for an ETF version of his flagship fund in March 2012, which is slated to trade under the ticker “MERK.”
As of Dec. 31, 2012, MERKX held a 31.5 percent exposure to the euro, as well as significant exposure to the Australian and Singapore dollars. Also worth noting is that MERKX targets only developed-market currencies and even holds a position in gold, which Merk considers the ultimate hard currency.
Moreover, these funds can also take negative exposures to certain foreign currencies if the situation warrants itself or the manager sees an opportunity, thereby benefiting when the dollar rises against the currency in question.
In a world where currency wars are beginning to brew as central banks engage in unilateral actions, it’s increasingly possible that the U.S. dollar can at times be more of a “safe haven” relative to a specific currency or currencies.
The recent plunge in the Japanese yen due to the political developments in Japan is a prime example.
MERKX actually held an 8.5 percent negative exposure to the yen at year-end 2012, while FORX is also capable of taking negative exposure to a foreign currency.
While it might be easy to pit FORX against Merk’s upcoming ETF once it launches, they may produce some very different returns, based on their current holdings. Their differing strategies might actually mean the two can be complements to each other, rather than competitors.
Either way, the currency space looks to be evolving.
Time will tell if investors on a larger scale will come to accept and embrace currencies as a viable long-term investment asset class, as opposed to using them simply for tactical or hedging purposes.
Still, it’s hard to overlook the current turmoil in the currency space and wonder if the time isn’t ripe for these types of funds to really shine.
At the time this article was written, the author had no positions in the securities mentioned. Contact Dennis Hudachek at email@example.com.
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