New Way To Play The Renminbi?

June 13, 2011

This month brought some exciting news for investors bullish on the Chinese renminbi, or RMB.

Rydex SGI, known for its CurrencyShares funds, filed with the Securities and Exchange Commission for a new RMB fund that will trade on the NYSE Arca, under the ticker “FXCH.”

I was excited when I first read about this filing. Rydex’s CurrencyShares is famous for its simple structure: It holds the underlying currency in a bank account, providing direct, one-for-one exposure to the currency in question.

I immediately thought about how FXCH would stack up against the WisdomTree Dreyfus Chinese Yuan Fund (NYSEArca: CYB), the current favorite among investors searching for exposure to the Chinese currency. CYB is currently the fourth-largest currency ETF, with over $650 million in assets under management.

Rather than holding the actual currency, CYB gains its exposure to the RMB by investing in nondeliverable forward (NDF) contracts. It was set up this way because the Chinese government has historically maintained a tight grip on its currency, not allowing investors to trade the RMB directly.

Up until recently, NDFs were the only choice, and that includes a Van Eck Global RMB exchange-traded note tracking an index that rolls over three-month NDF contracts continuously as they mature.

The problem with holding NDFs is that they’re forward contracts that are already pricing in an expected appreciation in the RMB. That can mute any rise in the fund when the exchange rate rises in your favor; you’re betting not against the actual exchange rate, but rather, against the NDFs’ view on the future exchange rate.

That said, funds that hold NDFs can get a significant uptick should the Chinese announce an unexpected revaluation, or allow their currency to appreciate faster than expected. The disparity in returns can clearly be seen in this one-year chart comparing the spot CNY/USD gains versus the total returns in CYB. While they move in the same general trend, there are momentary discrepancies.


CYB Total Returns vs. Spot Returns

Source: Bloomberg


So with Rydex’s new CurrencyShares Chinese Renminbi Trust providing real access to spot rates, one would expect FXCH to dominate CYB once it begins trading, right? Perhaps. I say perhaps because when we’re dealing with the RMB, it’s always worth digging a bit deeper.

In July 2010, the Chinese government announced the RMB will be allowed to appreciate (or depreciate) against a basket of currencies within a tight daily band. Right about the same time, offshore trading for the RMB began in Hong Kong.


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