FT Alphaville has previously delved deeply into the latest product offering from ETF Securities: “collateralised currency securities“, also known as ETCs.
We’re revisiting the topic, but while our conclusions remain unchanged — these are hugely complicated products — we would like to clarify one matter: how these products can expose investors to carry-trade returns.
Originally, we had been thrown by the following paragraph from the index methodology:
For the Total Return versions of the MSFX Indices based on the deliverable MSFX Currencies, in order to replicate the return of a constant fully collateralized strategy, the related MSFX Index will accrue interest daily at the (i) One-Month T-Bill Rate (“T-Bill”), in the case of the MSFX Currencies valued relative to the U.S. dollar and (ii) Euro Overnight Index Average rate (“EONIA”), in the case of the in the case of the MSFX Currencies valued relative to the Euro. Hence, the daily return on the related MSFX Total Return Index will be computed as the sum of the MSFX Currency return and the One-Month T-Bill return or EONIA return, as applicable.But now Felix Salmon over at Reuters offers some more insight (having initially, like us, been stumped by the matter). As he explained on Tuesday, how these products allow investors to play the carry trade is down to the way the indices rebalance on a daily basis. This rebalancing allows for overnight rate exposure:
…the funds essentially buy currency forwards expiring tomorrow, sell them just before expiry, and roll over into a new short-dated forward. These forwards are extremely liquid, and since that constant rolling one-day exposure in the forwards market does an excellent job of reflecting the differences in local interest rates.
While that’s not quite as good as investing in longer-dated paper, it’s certainly not a rate to be sniffed at.
As Nik Bienkowski of ETF Securities told Salmon:
…if the Aussie dollar ETC had existed for the past five years, holding it would have returned 4.8% per annum, before fees, over and above whatever you would have got from holding Aussie dollars alone. Fees are 39bp per year, accrued daily, so you genuinely can get a bit of carry out of these things.
That 4.8 per cent compares to an average RBA cash rate of 5.3 per cent in the same period.
Related links:
Introducing collateralised currency securities - FT Alphaville
Understanding currency ETCs – Felix Salmon, Reuters