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Collect Foreign Money Market Rates

The last time that I checked, local money market and CD rates were running in the 3.0% to 3.5% range. That’s not much compared to the 12% or so money market rates in Brazil, India, or South Africa.

Now, in theory, at least, there’s a way for individual investors to get in on that action via a new family of exchange-traded funds (ETFs) designed specifically for the purpose. Here are the details.

In May and June, exchange-traded fund manager Wisdom Tree partnered with Dreyfus to introduce seven new ETFs intended to allow U.S. investors access to foreign money market rates. In essence, Dreyfus provides the currency trading expertise, while Wisdom Tree markets the funds.

Currency Funds
The Wisdom Tree Dreyfus Currency Income ETFs include the Brazilian Real Fund (BZF), the Chinese Yuan Fund (CYB), the EURO Fund (EU), the Indian Rupee Fund (ICN), the Japanese Yen Fund (JYF), the New Zealand Dollar Fund (BNZ), and the South African Rand Fund (SZR).  

Most ETFs, as you probably know, are set up to track existing stock indexes, such as the S&P 500, or special indexes tracking a specific categories such as China stocks, or healthcare or energy stocks. Although they may be rebalanced occasionally, the indexes are essentially fixed.

By contrast, the new Wisdom Tree Currency ETFs are managed funds. According to Wisdom Tree, managers regularly review and adjust portfolio holdings as they see fit.

Wisdom Tree divides its currency ETFs into two categories: developed markets and emerging markets. The Euro and Japanese Yen funds are developed market ETFs, and the others are emerging market funds.

The developed market funds invest directly in local, investment grade, money market securities. However, because those types of securities are not readily available to foreign investors in the emerging markets, the portfolio managers employ a combination of U.S. money market securities and foreign currency contracts to emulate each emerging country’s local returns.

Money Market Rates
Here are the money market rates that Wisdom Tree is currently targeting for each currency: Brazilian Real: 12%, Chinese Yuan -1%, Euro 4%, Indian Rupee 12%, Japanese Yen: 1%, New Zealand Dollar: 8%, South African Rand: 12%. The negative Chinese Yuan targeted return reflects the difficulties of investing in that currency.

Currency Exchange Rates
However, there’s more to the story. If all goes as planned, the return that you receive would be the total of the targeted money market rate and the change in currency exchange rate of the foreign currency vs. the U.S. dollar. You profit if the foreign currency gains vs. the U.S. dollar, but you lose if the U.S. dollar strengthens.

Over the past 12-months, the U.S. dollar has fallen compared to four of the seven currencies covered by the Wisdom Tree ETFs. Had the currency funds been available a year-ago, considering only currency exchange rates, here’s how you would have fared over the past 12 months: Brazilian Real: +18%, Chinese Yuan +11%, Euro +15%, Indian Rupee –7%, Japanese Yen: +16%, New Zealand Dollar: -3%, South African Rand: -10%.

For example, excluding dividends, you would have made 18% if you had invested in the Brazilian Real, but lost 10% if you had bought the South African Rand instead. Your actual return would approximate the currency exchange rate gain or loss plus the money market rate.

Assuming that historical trends continue (of course, you can’t really assume that), Brazil’s strong currency gains, plus its 12% targeted dividend rate makes it an interesting candidate.

Expenses Subtract
One caveat, Wisdom Tree charges an annual expense ratio of 0.35% for the Euro and Japanese Yen, and 0.45% for the emerging market funds. Those numbers subtract from your total return. That’s not a big deal if you’re looking at Brazil’s targeted 12% annual dividend. But it is significant if you’re considering the Euro with its 4% target.

Dividend Details
Wisdom Tree intends to pay dividends quarterly for the Euro and the Yen funds, and annually (around year-end) for the others. However, you don’t have wait for the dividend pay dates to lock in the money market targeted returns.

For a fund, the net asset value is the total value of the fund’s assets expressed on a per-share basis. According to Wisdom Tree, the targeted money market return adds to each fund’s NAV on a daily basis. For example, for a targeted 12% annual return, excluding currency exchange rate changes, the NAV should increase by 1% in a month (the NAV then drops by the dividend amount when it’s paid). For exchange-traded funds, the share price usually closely tracks the NAV. For example, when I looked up the Brazilian fund on July 10, the NAV was $26.42 and the share price was $26.56.

Wisdom Tree displays the share price and NAV figures for each fund in almost real time on its site (www.wisdomtree.com). Get there by entering the fund’s ticker symbol on Wisdom Tree’s homepage.

Risky Business
The Wisdom Tree Dreyfus Currency Income ETFs offer an intriguing avenue for capturing high dividends if currency exchange rates go your way. However, historically, some very smart people have lost big money betting on the direction of currency exchange rates. You can’t assume that the U.S. dollar will remain weak vs. other currencies, especially if the Fed starts upping interest rates. Also, the Wisdom Tree funds are brand new and have no track record. Don’t put all of your eggs in this basket.

published 7/13/08

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