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Is Currency ETF A Right Investment Choice

01 Sep 2023

Introduction

Currency ETFs are pooled investment vehicles that hold foreign currency assets and trade on the stock exchange like shares. They aim to replicate the exchange rate movements of a foreign currency or a basket of currencies against the Indian rupee. For example, a USDINR ETF will track the value of the US dollar relative to the Indian rupee, and its price will increase or decrease accordingly.

Currency ETFs can be classified into single-currency ETFs and basket currency ETFs. Single currency ETFs focus on one foreign currency, such as the euro, the US dollar, or the British pound. Basket currency ETFs invest in a group of currencies that share common characteristics, such as emerging market currencies, Asian currencies, or European currencies. Let’s understand if investing in them is good for you.

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How do Currency ETFs work?

Currency ETFs function through the possession of deposits of foreign currency or derivatives contracts. These instruments mirror the fluctuations in exchange rates of the respective underlying currency or currencies. The fund manager of an ETF will buy or sell foreign currency assets to maintain the desired exposure and track the benchmark index as closely as possible.

Currency ETFs are listed and traded on the stock exchange like shares. As an investor, you may buy or sell units of this ETF through your broker or online trading platform. The price of this ETF unit relies on the demand and supply in the market, as well as the exchange rate movements of the underlying currency or currencies.

What are the advantages of Currency ETFs?

Currency ETFs offer unique advantages if you want to diversify your portfolios and hedge against currency fluctuations. Some of these advantages are:

  • They expose the FOREX market without opening a forex account or dealing with complex forex transactions.
  • They allow you to benefit from the appreciation or depreciation of a foreign currency or a basket of currencies against the Indian rupee.
  • Currency ETFs offer liquidity and transparency, as they are tradable on the stock exchange like shares, and their prices are updated in real-time.
  • They have low entry barriers, as they can be bought or sold in small quantities and have low expense ratios compared to other investment options.
  • You may use currency ETFs for hedging purposes. They may help you reduce your exposure to currency risk from your international investments, business transactions, or travel plans.

What are the disadvantages of Currency ETFs?

Some drawbacks and challenges of these ETFs are as follows:

  • They are subject to high volatility and uncertainty. They depend on the exchange rate movements of the underlying currency or currencies, which various economic, political, and social factors can influence.
  • Currency ETFs may not track their benchmark index perfectly, as they may incur tracking errors due to transaction costs, fund management fees, market inefficiencies, or regulatory restrictions.
  • They may have low trading volumes and liquidity, as they are a relatively new and niche investment option in India and may not attract enough interest from investors and traders.
  • Currency ETFs may have tax implications. Depending on the holding period, they may be treated as debt funds for tax purposes and may attract short-term or long-term capital gains tax.

How to invest in Currency ETFs?

Investing in currency ETFs is similar to investing in any other exchange-traded fund. Here is what you need to do

  • Open a demat account and a trading account with a broker/platform offering access to currency ETFs.
  • Research and select a currency ETF. You can use various sources of information, such as fund factsheets, prospectuses, websites, blogs, articles, or reports, to learn more about different currency ETFs available in India.
  • Place an order to buy or sell units of a currency ETF. You can use various order types to execute your trade, such as market orders, limit orders, stop-loss orders, or trailing stop-loss orders.
  • Monitor your portfolio performance and review your investment strategy periodically. You can use various tools and indicators, such as charts, graphs, technical analysis, fundamental analysis, or news updates, to track price movements.

Conclusion

Currency ETFs are an innovative and alternative investment option if you seek diversification or plan to hedge against currency fluctuations. They offer exposure to the foreign exchange market without the need for complex forex transactions. However, they also involve high volatility and uncertainty due to exchange rate movements. 

 

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