New Way To Play The Renminbi?

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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 mature.

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.

CYB Total Returns vs. Spot Returns

Source:Bloomberg

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 China ( CNY ) and the new offshore version that began trading in Hong Kong ( CNH ). 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.

Chinese Renminbi Spot Prices

Source:Bloomberg

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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Copyright ® 2011 Index Publications LLC . All Rights Reserved.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: CNH , CNY , CYB

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