Do you want to invest in currency ETFs but need help figuring out where to start? Consider checking out this post, as it takes you through different aspects of currency ETFs. Read on and find out everything involved!
What is Currency ETFs?
Currency ETF or Currency Exchange Traded Fund refers to a pooled investment that enables investors to monitor the performance of different currencies in the foreign exchange market. Leveraging currency ETFs, investors can gain exposure to changing exchange rates in one or more currency pairs.
Generally, currency ETFs aim to track the relative value of a basket of currencies. You can rely on these investment vehicles to hedge exposure to the foreign exchange market through a managed fund. However, you won’t have to shoulder the burden of placing individual trades. You can purchase currency ETFs like corporate stock shares.
How does a currency ETF differ from other ETFs?
Typically, most ETFs work as index funds to buy securities or other kinds of investments for tracking existing indexes on bond or stock markets. Currency ETFs, however, focus exclusively on the relativity between different currencies. Thus, consider them a strategic means of diversifying or hedging the currency risk in over-exposed portfolios of certain currencies.
In addition, currency ETFs allow you to speculate on currency fluctuations caused by different economic or geopolitical issues.
Understanding the importance of currency ETFs
Statistics claim that the forex market is the world's largest financial market. Using currency ETFs, you can gain exposure to foreign currencies and the risk probability in the forex market. You can consider ETFs a precise yet affordable instrument to step into the world of currency trading.
However, currency ETFs involve a few risks, like any other investment alternatives. While government issues securities are usually seen as safer investment alternatives, currencies possess a considerable level of risk. They can sometimes be volatile because interest rates, economic stances, and political conditions drive their value. However, they can be the best tool to speculate or hedge.
Types of currency ETFs
Before you move forward to investing in currency ETFs, it’s crucial to understand their types. Generally, the structure of the currency ETFs works as the primary determiner of its risks, potentials, and other considerations. Following is a quick explanation of various currency ETFs.
Exchange Traded Notes
Exchange Traded Notes or ETN refer to various unsecured debt instruments designed to track underlying indexes of securities. Besides, they aim to trade on major exchanges like stocks. ETNs are pretty identical to bonds; however, they don’t come with interest payments. In fact, their prices fluctuate like stocks. ETNs value is always indexed to a particular exchange rate or currency.
Grantor Trust
It’s a trust where the creator of the trust is considered the owner of the property and assets for income and estate tax purposes. Grantor Trust can be irrevocable or revocable. Typically, grantor trust holds the currencies in question in a bank account.
Commodity Pools
Commodity pools or collective investment schemes refer to organizations that pull currency from a group of investors to purchase a basket of commodities. These organizations are designed to maximize returns for their participants by sharing risks. Commodity pools generally hold future contracts for currencies.
Open-ended Trusts
These trusts hold most of their funds in treasury bills. However, they are exposed to foreign currencies through different forward currency contracts.
Currency ETFs: Pros and Cons
While currency ETFs offer a slew of benefits, they have some downsides as well. Following is a brief explanation of the advantages and disadvantages of currency ETFs.
Pros
Highly Affordable: Currency ETFs are considered an affordable investment scheme. A few years ago, currency investment was limited to professional traders, macro hedge funds, and institutional investors. However, currency Exchange Traded Funds have dragged the currency market within reach of every investor. You can now get exposure to different currencies without buying individual currencies.
Moreover, currency ETFs monitor every index. Therefore, the fund manager can replicate it closely, getting a scope to cherish a lower expense ratio than actively managed funds. What’s more, you don’t need to pay hefty transaction fees for buying and selling currencies. Besides, the management fees are significantly low.
Trade Speculations: You can rely on currency Exchange Traded Funds for speculating on currency valuations. All you need to do is blend them with other currencies.
Real-time prices: The best part is your can buy and sell currency ETFs at any time during trading hours and expect real-time prices. Furthermore, you can buy currency ETFs using your existing brokerage account. There is no need to make derivatives trades or individual currencies.
Portfolio diversity: You can add to a portfolio’s diversity by leveraging currency ETFs. Besides, you can use them as an effective hedging tool to measure the relative value of different currencies.
Cons
Volatile: Global currencies are volatile. Therefore, investing in currency ETFs may expose you to the risk of fluctuations triggered by economic or geopolitical issues.
Complicated taxation: For currency ETFs in India, you are taxed based on the structure of your chosen fund. Therefore, you will have to conduct enhanced research to understand the tax treatment of your purchased fund.
Bankruptcy: Remember, Exchange Traded Notes are unsecured debt notes issued by banks. If the issuing bank turns bankrupt, you will lose your funds.
Combined trades: When a relationship between two traded currencies fails to pan out as per your expectations, you can experience complexity.
Who should invest in currency ETF India?
In India, currency ETF has become highly popular among traders who want exposure to the currency market. However, you should be careful and consider a few things before you invest in currency Exchange Traded Funds. The considerations should include the following.
Past performance: Granted, previous performances never guarantee future returns for volatile assets like currency. However, studying their past performances may help you determine how sensitive they are to external factors.
Goal: It’s crucial to understand your investment objective before investing in currency ETFs. Before proceeding, you should prepare a clear investment blueprint and choose a currency ETF that goes well with your investment objective.
Price: Indeed, currency ETFs are cost-efficient. However, you still may have your specific investment budgets. Consider that before buying currency ETFs. Remember, you should always invest what you can afford to lose.
Frequently Asked Questions
ETFs or stocks - Which one is safer?
Both currency ETFs and stocks involve certain risks. It completely depends on the circumstances and performance of the stock or currency ETF and whether or not it will give you good returns.
Do you get dividends with currency ETFs?
No, most currency ETFs don’t involve dividends.
What should be the minimum amount for investing in an ETF?
There is no set limit. However, to incorporate diversification in your investment portfolio, you should start with a small percentage of the portfolio in ETFs. The said percentage, however, may vary depending on the investors and the risk-return balance.
Conclusion
To summarize, a currency ETF may enable you to enjoy fantastic returns. Besides, it may be a great tool to diversify your portfolio, leverage the fluctuation advantage in the forex market, and reduce overexposure to specific currencies. However, currency ETFs involve certain risks, and you should invest carefully to make the most of this popular investment alternative.