Currency ETFs gain popularity

Since their first currency related exchange-traded fund (ETF) was listed in December 2005, Rydex Investments’ Currency Shares ETFs have grown in popularity.

There are eight ETFs trading on the New York Stock Exchange (NYSE), each representing a separate currency fund. The most recent addition, a Japanese yen trust, began trading in early 2007. It shows the symbols for these ETFs and the currencies they represent.

Owning shares of a CurrencyShares ETF represents ownership of a fractional amount of currency contained in a corresponding fund. The total amount in the fund remains constant. The fluctuations in the currency value compared to the U.S. dollar cause the ETF price to move up and down.

The ETFs’ prices are affected by the same factors that cause rates in the currency markets to shift: economic developments, currency restrictions, and local interest rates.

An advantage is the monthly distribution of profits from interest: Because the currency funds are held in their respective country, each fund earns interest at that country’s current rate. The profit from these interest rates is converted back into U.S. dollars. In the event the profit exceeds the 0.4-percent expense ratio charged by Rydex, the remainder is returned to the stockholders on a prorate basis, usually as a credit to their brokerage accounts.

Since the distributions are wholly dependent on constantly shifting interest and exchange rates, a return is not guaranteed. As shown in it, seven of the eight ETFs paid out distributions in January from profits earned in December. Japan’s nearly negligible interest rates return little profit and therefore do not exceed Rydex’s sponsorship fee.

Unlike stock dividends, these ETF stocks are not divided and then dispensed among the CurrencyShares ETF stockholders. Each stock always represents the same amount of money relative to its fund no matter what the distributions are.

Rydex’s intention is to let investors take advantage of forex movements and diversify their portfolios. But Steve Sachs, trade director at Rydex, says the company was surprised to see the ETFs used by money managers of large institutions unable to trade in currencies.

It shows how currency-ETF trade volume has increased since the euro trust began trading more than two years ago. Although Sachs said there is nothing new on the horizon, more currency funds could emerge in the future, including the Chinese yuan.

While very active traders are not likely to benefit from the monthly distributions, these ETFs offer another way to trade the forex market. For the longer-term investor, they provide a chance to capitalize on shifting currency values and earn a modest monthly payout.