Rydex SGI, known for its CurrencyShares funds, filed with the
Securities and Exchange Commission for a new RMB fund that will
trade on the NYSE Arca, under the ticker "FXCH."
I was excited when I first read about this filing. Rydex's
CurrencyShares is famous for its simple structure:It holds the
underlying currency in a bank account, providing direct,
one-for-one exposure to the currency in question.
I immediately thought about how FXCH would stack up against the
WisdomTree Dreyfus Chinese Yuan Fund (NYSEArca:CYB), the current
favorite among investors searching for exposure to the Chinese
currency. CYB is currently the fourth-largest currency ETF, with
over $650 million in assets under management.
Rather than holding the actual currency, CYB gains its exposure
to the RMB by investing in nondeliverable forward (NDF) contracts.
It was set up this way because the Chinese government has
historically maintained a tight grip on its currency, not allowing
investors to trade the RMB directly.
Up until recently, NDFs were the only choice, and that includes
a Van Eck Global RMB exchange-traded note tracking an index
that rolls over three-month NDF contracts continuously as they
The problem with holding NDFs is that they're forward contracts
that are already pricing in an expected appreciation in the RMB.
That can mute any rise in the fund when the exchange rate rises in
your favor; you're betting not against the actual exchange rate,
but rather, against the NDFs' view on the future exchange rate.
That said, funds that hold NDFs can get a significant uptick
should the Chinese announce an unexpected revaluation, or allow
their currency to appreciate faster than expected. The disparity in
returns can clearly be seen in this one-year chart comparing the
spot CNY/USD gains versus the total returns in CYB. While they move
in the same general trend, there are momentary discrepancies.
So with Rydex's new CurrencyShares Chinese Renminbi Trust
providing real access to spot rates, one would expect FXCH to
dominate CYB once it begins trading, right? Perhaps. I say perhaps
because when we're dealing with the RMB, it's always worth digging
a bit deeper.
In July 2010, the Chinese government announced the RMB will be
allowed to appreciate (or depreciate) against a basket of
currencies within a tight daily band. Right about the same time,
offshore trading for the RMB began in Hong Kong.
This led to two RMB markets-an onshore version that trades in
) and the new offshore version that began trading in Hong Kong (
). According to the registration statement, FXCH will hold CNH-not
the onshore market that's followed by most investors.
While CNY and CNH are technically the same currency, they trade
on two separate markets and can have different exchange rates.
While the CNH market is rapidly growing (CNH's daily turnover is
now well over $1 billion compared with the NDF market, which is
over $2 billion), it's still relatively new, and demand still often
outpaces supply, causing it to diverge from spot USD/CNY rates at
times, as the chart below shows.
But aside from how they gain exposure to the RMB, the two funds
are also structurally different. CYB is structured as an open-end
fund under the Investment Company Act of 1940, while FXCH will be
structured as a grantor trust under the Securities Act of 1933.
This means that the tax implications can also be different.
With CurrencyShares, income from any distributions and realized
gains made from selling shares are generally taxed as ordinary
income, regardless of how long the shares were held.
With the WisdomTree fund, distributions are either taxed as
ordinary income, short-term gains, long-term gains or even a
combination of the three. And, according to the prospectus, gains
from selling shares in CYB are also generally taxed as long-term
gains if held for more than a year.
So investors have several factors to consider. It'll be
interesting to see how they weigh the pros and cons of the two
funds once FXCH begins trading. With a controlled currency and the
uncertainties surrounding the RMB, there just might be a case to
hold both funds in a portfolio looking to gain exposure.
That said, the significance of this new fund filing can't be
ignored. It certainly caught my attention.
For those interested in RMB, keep an eye out for FXCH.
Disclosure:I am currently long CYB.
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