The Big Picture For The Week Of March 19, 2006

The other day I quoted and linked to the Businessweek blog post about some new currency ETFs in the works.

I am fairly excited about being able to access currencies in this manner. I'll have more commentary on these as they come to market but I thought it would be worthwhile to address what currency ETFs will not do.

What they will not do is be a substitute for growth vehicles, like stocks. Since the Euro Currency Trust (FXE) listed a few months ago it is up not quite 2%. In the same time the iShares Euro 350 Index Fund (IEV) is up about 8%.

The things that move equities are not necessarily the things that move currencies, sometimes yes but sometimes no. The meaning here is that you should not buy FXE thinking it will always serve as a proxy for European stocks.

Most allocation models assess stocks, bonds and cash. I think that the currency ETFs will radically alter the cash part of the equation. One of the proposed ETFs is for the Swedish krona. I really am surprised that this would be one of the first ones as the USDSEK cross rate gets very little attention compared to some other crosses.

Be that as it may, the krona could be a good example of how this would work. A while back I wrote an article for TSCM about iShares Sweden (EWD). One possible catalyst I pointed to was that the krona could do well against the dollar because the Riksbank is just starting a rate hiking cycle. Since the article published, EWD is up about 8% and the krona is up about 2.5% versus the dollar.

This is just an example. Where equities are concerned, 2.5% is not a big deal. Where cash is concerned, adding as much as a couple of hundred basis points in returns to a portion of cash without taking equity market risk is compelling.

While it is compelling it is not riskless. In the last two months the krona could have been down by that much, or more. A strategy where some cash is parked in certain currency ETF will be appropriate for a lot of folks.

On a theoretical note, I wonder if the currency ETFs will alter portfolio management strategies to the point of being revolutionary. We'll have to check back in a couple of years on that one.