Traders looking for a way to profit from the latest battles in
the currency wars have been intrigued by the prospect of earning
double-digit dividends from ETFs that invest in foreign currency.
But how real are these yields?
The larger of the two funds that tracks the Indian rupee,
WisdomTree Dreyfus Rupee (
ICN
,
quote
), has appreciated 4% year to date while the underlying currency
has only recovered 1.9% over that time frame.
A casual investor might attribute that outperformance to
manager skill or even a fluke tracking error created by the way
currency funds work.
While a portfolio like ICN does trade directly in currency
futures contracts, the bulk of the holdings are various types of
U.S. Treasury paper and money market instruments selected to
mirror developments in the foreign exchange markets.
These holdings will generally generate income from interest
payments, unlike the currency contracts themselves, which rise
and fall according to prevailing exchange rates.
Because of this, in theory a "currency" ETF can accumulate
both capital gains and interest like a traditional bond fund.
This cash then needs to be either reinvested or distributed to
shareholders in the form of dividends.
In the past, funds tracking relatively strong currencies like
the Brazilian real (
BZF
,
quote
) have paid massive dividends as both their futures trades and
their bets in the money markets paid off. BZF, for example, paid
an effective dividend of 28.84% last December, while ICN paid
15.74%.
Unless a currency fund pays the dividend, its performance
rapidly diverges from the underlying exchange rates, making its
mandate meaningless.
Investors who see this might suspect that after the rupee --
and the real, for that matter -- weakened against the dollar last
year, the associated funds are now "undervalued" and their
effective yields have soared to compensate.
But remember: posted yields are historical only, and do not
reflect current performance or future dividend payment
decisions.
ICN paid the equivalent of 15.74% last year. This year, its
relative outperformance against the rupee has come to maybe 2%
that can be paid out to shareholders if it's still there in
December.
The money markets aren't helping here. On a pure
yield-to-maturity basis, ICN's Treasury bills still pay the
roughly 0.08% a year that investors can get anywhere else.
Adjusted for fees, and the official SEC "yield" here is a
cringe-inducing -0.35%.
In theory, the rupee can soar another 13.74% in the next eight
months and ICN can repeat its massive payout from last year.
After all, both ICN and the rupee have
weakened
9% to 10% since the last dividend announcement, and that's a lot
of room to recover.
But in practice, those looking for a reliable annual check
from the fund company most likely need to look elsewhere.
