With China widening its currency trading bands, we ask what the best ETF to play the strong Chinese currency is: CYB, CNY or FXCH?
The People's Bank of China (PBOC) announced recently that it would widen the trading band of the yuan. That could bring some interesting moves that'll separate the winners from the losers among Chinese renminbi currency ETFs.
The Chinese renminbi (aka "the yuan") is pegged to a basket of currencies, but it's allowed to fluctuate on a daily basis. In a move to display confidence in the Chinese economy, the PBOC announced it would widen the daily band from 0.5 to 1 percent—allowing for greater volatility and potentially a faster rate of appreciation over time.
The news was heralded, as many believe the yuan to be undervalued by as much as 40 percent. Could the yuan be on the ascent again?
For ETF investors, the last time the yuan made a major move upward, it revealed some distinct differences between the two major choices at the time: the Market Vectors Chinese Renminbi USD ETN (NYSEArca: CNY) and WisdomTree Dreyfus Chinese Yuan Fund (NYSEArca: CYB).
When the yuan began to appreciate steeply in early 2010, CYB outperformed CNY in a "battle of the structures." The key difference was that CNY is an ETN that tracks the S&P Chinese Renminbi Total Return Index, which tracks the performance of three-month currency contracts that roll over into new contracts at the end of each period. Unfortunately, those contracts had already priced in much of the yuan's expected appreciation, with the result that they didn't track as well when the yuan went higher.
CYB, on the other hand, was a 1940s Act fund that had an element of active management—the portfolio managers bought and sold nondeliverable forward contracts on the yuan while holding the collateral in short-term securities. Because CYB's portfolio managers had chosen longer-termed contracts at the time the appreciation started, they were able to do a better job of tracking the yuan's appreciation in early 2010. Essentially, forward expectations rallied more than near-term deliverables.
Today investors have a third choice at their disposal: the CurrencyShares Chinese Renminbi Trust (NYSEArca: FXCH). The fund holds physical currency—specifically, offshore Chinese renminbi that's traded in Hong Kong. That sounds like it should track perfectly to spot, but the truth is a little muddier. As this chart shows, gaps sometimes open up between mainland renminbi and Hong Kong renminbi.
Over longer periods, however, arbitrage brings the two valuations closer together.
The widening of the yuan's band may seem like an immediate sign to jump into one of these ETFs, but let's not forget that it's still a bit unpredictable how the yuan may move in the short term. As concerns grow about the Chinese economy slowing down, the widened band is a double-edged sword that could allow the renminbi to depreciate in the case that there's a flight to quality.