Bet On The Dollar

September 11, 2006

PowerShares files for new ETFs based on the U.S. Dollar Index, allowing investors to bet on the strength of the U.S. dollar.

Capitalizing on the currency craze,  PowerShares and its alternative assets partner Deutsche Bank have filed papers with the Securities and Exchange Commission (SEC) for the right to launch two exchange-traded providing "bullish" and "bearish" exposure to the U.S. Dollar Index.  The USDX, as the index is known, is hugely popular with currency traders, who trade futures on the index through the New York Board of Trade's FINEX platform.  The index compares the value of the dollar to a GDP-weighted portfolio of six global currencies: the euro, British pound, Canadian dollar, Japanese yen, Swedish krona and Swiss franc.

Euro

57.6%

Japanese yen

13.6%

British pound

11.9%

Canadian dollar

9.1%

Swedish krona

4.2%

Swiss franc

3.6%

The two funds will be called the PowerShares DB US Dollar Index Bullish and Bearish funds, respectively.  The funds will trade on the American Stock Exchange, and will charge an expense ratio of 55 basis points. Holding USDX futures as the core asset, the funds will invest collateral money in U.S. treasuries, earning interest (at current rates) of 5.08 percent.  That means, before the underlying contract moves an inch, the funds will return 4.53 percent.

The prospectus is available here.

(As a side note, the rise in short-term interest rates has made futures-based ETFs vastly more attractive than they once were -- and perhaps more attractive compared to equity funds, as well.  Most of these contracts, such as the commodity funds from iShares and PowerShares, pay interest income based on Treasury rates.  With rates tipping 5 percent, that's a big leg up over a stock fund. Remember, stocks' long-term historical return is around 10 percent, and many expect that to shrink to 5-8 percent going forward; with a 5 percent leg-up, it won't take much for futures-based funds to deliver higher returns.)

One thing should be clear about the new PowerShares filings: they are not investments in the classic sense of delivering long-term increasing returns. Ultimately, absent the interest income, the two funds are a zero sum game, as are any matched bets on currency comparisons. One-way bets could always pay off over the long-term, but the long-term track record of these two funds is not compelling: the long fund has delivered compound returns of 2.3 percent per year since 1988, while the short fund has returned 6.2 percent.

Still, as trading tools that let investors hedge currency exposure or make bets on the geo-economic developments, they are certainly of interest. USDX futures volume is enormous - some 28,000 contracts traded each day in June. Investors have already embraced currencies as an equitized ETF product, too: a Rydex ETF (FXE) tied to the value of the Euro has attracted nearly $700 million in assets over the past year, inspiring Rydex to launch six additional currency ETFs. The new USDX funds make a nice addition to those choices.

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