Merk’s Hard Currency ETF

April 04, 2012

Axel Merk has upped the ante with plans to bring his flagship Hard Currency mutual fund to market in an ETF wrapper.

According to the filing, the ETF version of the Merk Hard Currency Fund (MERKX) will trade on Arca, the New York Stock Exchange’s electronic trading platform, with the ticker, “HRD.” Like the mutual fund, the new ETF will be actively managed by Merk himself.

While fund fee details are still undisclosed, it’s widely expected that HRD will cost less than MERKX’s annual cost of 1.30 percent.

Launched in May 2005, MERKX aims to profit from the falling U.S. dollar relative to a basket of currencies from countries that the manager believes to have sound monetary policies. Also included in the portfolio is gold, which Merk considers to be the only true currency with intrinsic value.

As much as I’ve been a fan of MERKX for years, I’ve always felt that paying 1.30 percent for a currency fund was a bit steep, even though it’s a “no-load” fund. So naturally, this ETF filing was exciting news to me.

Currency Exposure Strategy

When considering currency ETPs, it’s essential to know its investment strategy. Knowing how the fund is structured can also lead to significantly different tax implications.

Certain funds, like WisdomTree’s currency funds, hold locally denominated money market instruments and/or use forward currency contracts. However, using forward contracts can at times produce diverging returns from the underlying currency, for better or worse.

Others, like Guggenheim’s CurrencyShares, hold the underlying currency notes in deposit accounts. Shares are backed by the actual currency in question, so they provide direct exposure to the currency relative to the dollar.

HRD will be structured much like the WisdomTree funds. According to its filing, HRD will hold local money market and short-term debt instruments, including sovereigns, as well as forward currency contracts. Its gold exposure will be through exchange-traded gold products.

If fact, one can even make the argument that HRD will be more of a hybrid of currency and fixed-income fund. Add gold to the mix, and HRD can even pass as an asset allocation fund of sorts.

Since HRD will be structured as an open-end fund, it has some tax benefits—gains should qualify for the 15 percent long-term rate if shares are held more than a year. In comparison, all gains in CurrencyShares ETFs are taxed as ordinary income.

An important side note to consider is that the current tax code is set to expire at the end of 2012, unless extended. So investors should keep an eye out for developments on this front in the coming year.

Currency Composition

MERKX doesn’t specifically limit itself to developed-market currencies, but based on its holdings, it’s pretty clear that Merk is banking heavily on the currencies of commodity-producing developed nations.

As of Feb. 29 of this year, MERKX was heavily weighted—roughly 60 percent—in the Australian dollar, Canadian dollar, Norwegian krone and New Zealand dollar.

Interestingly, the WisdomTree Dreyfus Commodity Currency Fund (NYSEArca: CCX) equal-weights these same four developed-market currencies, along with four other emerging market commodity currencies—the Brazilian real, the Russian ruble, the Chilean peso and the South African rand.



So, if HRD were to launch today, it would predominantly look like a developed-market, commodity-currency fund—with a touch of gold and the euro, at 9 percent and 9.7 percent, respectively.

It’s important to remember that HRD is actively managed, so Merk can alter the portfolio on a whim, depending on changes in macroeconomic conditions or central bank actions around the world.

Just to show how quickly these changes can be implemented, in the first three weeks of March, Merk took his holdings of the Japanese yen from 4.2 percent to zero.

That decision was based on the Bank of Japan’s announcement of a new inflation target, which pummeled the yen in the past month and a half.

Currency Funds As An Investment Tool

In general, the idea of using currencies as an investment tool hasn’t quite taken off in the investment world. As an example, while MERKX is one of the largest and most popular currency mutual funds, it’s still only a $550 million fund.

So, I’m not expecting any immediate investor mania for HRD, the likes of what we saw with the high-profile launch of Bill Gross’ Pimco Total Return ETF (NYSEArca: BOND) last month.

But with sovereign debt issues in much of the developed world causing coordinated central-bank stimulus on an unprecedented level all around the world, we’re clearly in uncharted waters.

If Merk and Gross are correct in their predictions that more “quantitative easing” programs are on the way from the Federal Reserve, I can see a fund like HRD gaining followers.

For those skeptical of currency funds as an investment play, just take a look at the returns of MERKX versus the SPDR S&P 500 ETF (NYSEArca: SPY).

Believe it or not, MERKX has actually outperformed the broad equity markets since its inception in May 2005.


Total Returns since 5/10/05: DXY vs MERKX vs SPY

Source: Bloomberg


MERKX also trounced the returns of the inverse of the U.S. Dollar Index by more than 37 percent.

Of course, you can make the case that the U.S. Dollar Index is outdated and that the fund’s exposure to gold played a role in its outperformance.

Still, that’s pretty impressive fund management.

The launch of HRD should provide a quick and cheaper way to get a slice of a solid fund managed by one of the top currency experts in the world. To me, it’s the launch to watch in the coming months.


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