Currency ETFs and ETNs
Overview of Currency ETPs
Exchange-traded products (ETPs) provide retail investors access to currency markets without opening a forex account or trading futures. These products track currency values, offering exposure to both appreciation and depreciation scenarios.
Currency ETPs fall into two main structural categories:
ETFs (Exchange-Traded Funds): Hold actual assets (currency deposits, short-term government securities) and are regulated under the Investment Company Act of 1940.
ETNs (Exchange-Traded Notes): Unsecured debt obligations of the issuer that promise to pay returns linked to a currency index. No actual currency is held.
This structural difference has significant implications for credit risk and tax treatment.
Major Single-Currency ETFs
The most liquid currency ETFs track individual major currencies against the US dollar:
| Ticker | Name | Currency | Expense Ratio | AUM | Avg Daily Volume |
|---|---|---|---|---|---|
| FXE | Invesco CurrencyShares Euro Trust | EUR | 0.40% | $220M | 350,000 |
| FXY | Invesco CurrencyShares Japanese Yen Trust | JPY | 0.40% | $180M | 250,000 |
| FXB | Invesco CurrencyShares British Pound Trust | GBP | 0.40% | $85M | 80,000 |
| FXA | Invesco CurrencyShares Australian Dollar Trust | AUD | 0.40% | $95M | 60,000 |
| FXC | Invesco CurrencyShares Canadian Dollar Trust | CAD | 0.40% | $110M | 70,000 |
| FXF | Invesco CurrencyShares Swiss Franc Trust | CHF | 0.40% | $180M | 90,000 |
These CurrencyShares products hold foreign currency in deposit accounts. When you buy FXE, the fund holds euros. Returns come from two sources:
- Currency appreciation/depreciation: Changes in the EUR/USD exchange rate
- Interest income: Interest earned on euro deposits (minus expenses)
Net return = Currency return + (Foreign interest rate - Expense ratio)
With euro short-term rates around 3.5% and the expense ratio at 0.40%, FXE generates approximately 3.1% annualized from interest, plus or minus currency moves.
Dollar Index and Basket Products
For broader USD exposure, several products track the US Dollar Index (DXY) or similar baskets:
| Ticker | Name | Strategy | Expense Ratio | AUM |
|---|---|---|---|---|
| UUP | Invesco DB US Dollar Index Bullish Fund | Long USD | 0.75% | $550M |
| UDN | Invesco DB US Dollar Index Bearish Fund | Short USD | 0.75% | $50M |
| USDU | WisdomTree Bloomberg U.S. Dollar Bullish Fund | Long USD | 0.50% | $200M |
UUP and UDN track the Deutsche Bank Long/Short US Dollar Index Futures, which follows the DXY composition:
- Euro: 57.6%
- Japanese Yen: 13.6%
- British Pound: 11.9%
- Canadian Dollar: 9.1%
- Swedish Krona: 4.2%
- Swiss Franc: 3.6%
USDU uses a more diversified, trade-weighted approach with exposure to developed and emerging market currencies.
These products use futures contracts rather than physical currency, introducing roll yield (positive or negative) as an additional return component.
ETF vs. ETN Structure
The distinction between ETFs and ETNs carries important implications:
ETFs
Structure: Regulated funds that hold assets
Credit risk: Minimal - assets are segregated from sponsor
Tracking: May have small tracking error due to expenses and operational factors
Tax treatment: Subject to complex rules; interest income taxed as ordinary income, currency gains may be treated as Section 988 ordinary income
Examples: FXE, FXY, FXB, UUP
ETNs
Structure: Unsecured senior debt of the issuing bank
Credit risk: Full exposure to issuer default. If the bank fails, ETN holders are unsecured creditors
Tracking: Typically precise tracking (no tracking error) since the note simply promises index returns
Tax treatment: Generally treated as prepaid forward contracts; gains taxed at long-term capital gains rates if held over one year (consult tax advisor)
Examples: Many leveraged currency products
Credit risk example: When Lehman Brothers failed in 2008, its ETNs became nearly worthless overnight. ETN investors should assess issuer creditworthiness - major issuers include Bank of America, UBS, and Credit Suisse (now UBS).
Leveraged and Inverse Products
Leveraged currency ETPs amplify daily returns:
| Ticker | Name | Leverage | Expense Ratio | Daily Reset |
|---|---|---|---|---|
| YCL | ProShares Ultra Yen | 2x Long JPY | 0.95% | Yes |
| YCS | ProShares UltraShort Yen | 2x Short JPY | 0.95% | Yes |
| EUO | ProShares UltraShort Euro | 2x Short EUR | 0.95% | Yes |
Critical: Daily Reset and Compounding
Leveraged products reset daily, which creates significant deviation from expected returns over longer periods.
Example: 2x Long EUR product over two days
Day 1: EUR/USD rises 2%
- Spot return: +2%
- 2x product: +4%
- Product NAV: 100 → 104
Day 2: EUR/USD falls 2%
- Spot return: -2%
- 2x product: -4%
- Product NAV: 104 → 99.84
Two-day spot return: (1.02 × 0.98) - 1 = -0.04% Two-day 2x product return: (1.04 × 0.96) - 1 = -0.16%
The leveraged product lost 0.16% while 2x the spot return would suggest -0.08%. This "volatility decay" compounds over time and is more severe with higher volatility.
Rule of thumb: Leveraged products are designed for daily trading, not long-term holding. Extended holding periods in volatile markets consistently underperform expected leveraged returns.
Expense Ratios and Tracking Error
Currency ETP costs vary significantly:
| Product Type | Typical Expense Ratio | Additional Costs |
|---|---|---|
| Single currency ETFs | 0.40% | Minimal |
| Dollar index products | 0.50-0.75% | Futures roll costs |
| Leveraged products | 0.95% | Financing costs, daily reset drag |
| Currency-hedged equity ETFs | 0.35-0.60% | Hedge roll costs |
Tracking error sources:
- Expense ratio drag: Directly reduces returns
- Futures roll yield: Can be positive or negative depending on forward curve
- Sampling/optimization: Some products don't fully replicate the index
- Cash drag: Uninvested cash earns less than the benchmark
- Rebalancing timing: Daily vs. real-time benchmark calculation
Single currency ETFs like FXE typically track well, with tracking error under 0.10% annually. Dollar index products using futures may have 0.50-1.00% tracking error due to roll dynamics.
Use Cases
Tactical Currency Views
Investors with directional views on currencies can express them through ETPs:
Scenario: Expect EUR/USD to rise from 1.08 to 1.15 over 6 months
Options:
- Buy FXE for 1x exposure
- Buy a 2x EUR product for leveraged exposure (with daily reset risk)
- Sell UUP for inverse USD exposure
Position sizing: A $10,000 position in FXE with EUR/USD moving from 1.08 to 1.15 (6.5% move) generates approximately $650 gain plus interest income.
Portfolio Hedging
Currency ETPs can hedge foreign currency exposure in equity portfolios:
Scenario: Hold $100,000 in European stocks, want to hedge EUR exposure
Approach: Buy $100,000 of UUP or sell $100,000 equivalent of FXE short
Limitation: Imprecise hedge due to DXY composition (only 57.6% EUR) and tracking error. Currency-hedged equity ETFs (HEDJ, DBEF) are typically more efficient for this purpose.
Yield Enhancement
In periods when foreign interest rates exceed US rates, currency ETPs may offer yield:
Example (hypothetical high-rate environment):
- Australian dollar deposits yield 5.0%
- FXA expense ratio: 0.40%
- Net yield: 4.6% plus any AUD appreciation
Current environment: With US rates elevated, most developed market currency ETFs offer lower yields than US alternatives, making this strategy less attractive.
Product Comparison Table
| Factor | Single Currency ETF | Dollar Index ETF | Leveraged Product |
|---|---|---|---|
| Complexity | Low | Medium | High |
| Expense ratio | 0.40% | 0.50-0.75% | 0.95% |
| Tracking precision | High | Medium | Daily only |
| Holding period | Any | Any | Short-term |
| Credit risk | None | None | Varies (ETN) |
| Liquidity | Good | Good | Moderate |
| Yield component | Yes | Minimal | No |
| Best use | Currency view, hedge | USD directional | Day trading |
Checklist Before Investing
- Confirm ETF vs. ETN structure; assess issuer credit for ETNs
- Understand expense ratio impact on expected returns
- For leveraged products, verify daily reset mechanics and volatility decay
- Check liquidity (average daily volume, bid-ask spread)
- Verify tax treatment with advisor (ordinary income vs. capital gains)
- For hedging, confirm correlation with underlying currency exposure
- Review tracking error history relative to benchmark
- Understand roll yield for futures-based products
Currency ETPs provide accessible tools for expressing currency views or managing currency risk. Single-currency ETFs offer straightforward exposure with reasonable costs. Dollar index products provide diversified USD exposure. Leveraged products serve short-term traders but carry significant risks for longer holding periods. Understanding the structural differences and cost components helps investors select appropriate products for their specific objectives.