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WisdomTree : How and why currency fluctuations can impact ETP returns

Investors looking to invest in Exchange Traded Products (ETPs)—whether that is a fund or a note—may notice there are different currencies associated with the instrument…….

These currencies can have a significant impact on the return of the product, and therefore it’s important to understand how they work and why they fluctuate. This article seeks to offer some clarity to investors and traders around how currencies in ETPs work.

The key information to be aware of

Firstly, it’s important to find out what index the ETP tracks and what currency that index is quoted in. For example, the NASDAQ 100 is quoted in USD, the FTSE MIB is quoted in EUR and the FTSE 100 is quoted in GBP.

Next, look at the base currency and Net Asset Value (NAV). The base currency is generally the same as the currency the index is quoted in and the NAV is also typically quoted in the base currency. However, this is where it can get tricky: the ETP can also have a price or ‘indicative’ NAV which is quoted in multiple currencies.

This means that while ETPs are issued and redeemed in their base currency, they may be traded in multiple currencies and on different exchanges. Ultimately this facilitates trading and settlement by giving the investor the ability to buy the ETP efficiently through their own local exchange.

For example, a 3x short 10-year US Treasuries ETP has both its base currency and NAV in USD and trades in GBx and USD on the London Stock Exchange and EUR on the Borsa Italiana and Deutsche Börse Xetra.

ETP performance of a 3x short 10-year US Treasuries ETP on the Borsa Italiana

The return of each ETP will be different depending on the base currency of the ETP. It has its base currency and NAV in USD but quotes in EUR on the Borsa Italiana. In the table below, we show a hypothetical example indicating the daily movement of the NAV (in USD) for this ETP and include the daily change of the EUR-USD exchange rate. 

The EUR price of the ETP is affected by both the change in the ETP’s price in USD and the EUR-USD exchange rate.

 

NAV (USD)

Change (%)

EUR- USD

Change (%)

NAV (EUR)

Change (%)

Day 1

100

 

1.15

 

86.96

 

Day 2

105

5.0%

1.10

-4.3%

95.45

9.8%

Day 3

105

0.0%

1.05

-4.5%

100.00

4.8%

Day 4

100

-4.8%

1.10

4.8%

90.91

-9.1%

 

Source: WisdomTree, illustrative example. Past performance is not indicative of future results.

In the above example over the four-day period, overall the NAV in USD was unchanged, while the EUR-USD exchange rate weakened from 1.15 to 1.10. This meant that overall while the NAV in USD was flat, an investor who traded in Euros would have had an overall return of 4.5%, which was purely a reflection of the change in the exchange rate.

Looking at the hypothetical returns during the period, on Day 3 to Day 4 the NAV in USD fell by 4.8%, while the EUR-USD exchange rate rose by 4.8% from 1.05 to 1.10. The impact of this was to reduce the NAV in EUR from 100 to 90.91 resulting in a decrease of 9.1%.

This relatively simple example demonstrates that for an ETP where the underlying exposure has its NAV in a currency that differs from the listing currency, it is important to take note of both sets of returns.

Impact of currencies over time

The chart below shows the cumulative % change in NAV (USD) for the same ETP, alongside the EUR-USD spot rate and the NAV in EUR between December 2016 and September 2017.

As the USD strengthens versus EUR—in other words, it costs less USD to buy one EUR—the EUR-USD line moves down, while if the EUR strengthens versus USD—in other words, it costs more USD to buy one EUR—the EUR-USD line moves up. Over the period shown below, the ETP decreased by 6.06% in USD terms, while it decreased 16.3% in EUR terms as the USD weakened versus EUR by 12.1%.

3TYS Cumulative Change in NAV (USD), NAV (EUR) and EUR/USD

Data from December 2016 to September 2017.

Source: WisdomTree, illustrative example. Past performance is not indicative of future results.

For this reason, if you invest in an ETP in a currency different to the currency of the index of such ETP, it is important that you are aware of the impact that movements in the exchange rate between such currencies can have on your investment.   

 

Source: ETFWorld.co.uk

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