Low-Cost ETFs for Trading China’s Yuan

10/06/2011 6:00 am EST

Focus: FOREX

Michael Johnston

Co-Founder and Senior Analyst, ETF Database

Recently released ETFs offer traders and investors low-cost exposure to vehicles designed to profit from the continued appreciation of the Chinese yuan against the US dollar and other world currencies.

Rydex, the firm behind the CurrencyShares suite of exchange traded products, made a splash with the latest addition to its product lineup on Tuesday. The recently-launched CurrencyShares Chinese Renminbi Trust (FXCH) will offer exposure to the official currency of the People’s Republic of China, bringing the total number of currency products offered by the company up to ten.

“The renminbi has become an important currency in the world, and the China growth story is expected to continue long term,” said Jim King, an ETF portfolio manager at Rydex|SGI.

“The Chinese Renminbi Trust offers investors a way to participate in China’s burgeoning economy, as well as diversify their portfolio with currency exposure,” he said.

The value of the Chinese currency, often known as the yuan, has been a hot topic for the last several years. The international community, including Treasury Secretary Geithner, has regularly implied that China has kept the official value of its currency depressed in order to boost exports. Beijing has gradually moved to allow the currency to appreciate, though perhaps at a much slower pace than many would suggest as optimal.

The US Senate recently passed a bill that would impose tariffs on exports from countries with undervalued currencies, a list that would presumably be headlined by China (see the enormous candles printed a few days ago on the daily charts below).

Though the outcome of that legislation in the House is uncertain, the move appeared to frustrate China; the People’s Bank of China issued a statement saying that the bill could “seriously affect” exchange rate reform or potentially lead to a trade war.

The general expectation is that the Chinese currency will gradually appreciate against the dollar and other currencies in coming years; FXCH allows investors to participate in that price appreciation. Few expect a rapid acceleration of the renminbi’s valuation; as such, FXCH can be seen as an opportunity for slow, steady growth as opposed to quick appreciation.

Under the Hood

Like all CurrencyShares products, FXCH is not a “true” 1940 Act exchange traded fund; rather, it is structured as a grantor trust. The underlying assets of the fund will consist of Chinese renminbi-denominated deposits, which allows FXCH to respond to changes in the US dollar price of the Chinese currency. If the renminbi appreciates relative to the greenback, FXCH can be expected to appreciate as well.

As part of China’s movement towards a more flexible currency, the government has introduced two versions of the renminbi: an onshore version and an offshore version. That arrangement was set up in order to allow an orderly introduction of the Chinese currency to international trade while still protecting Chinese banks from external shocks.

Generally, the offshore version trades at a premium to the onshore renminbi, because it is freely convertible in Hong Kong. Recently, however, that relationship flipped as the value of the offshore currency sank on concerns about the global economy.

The currency held by the new trust is the offshore version.

NEXT: How It Compares to Existing Chinese Yuan ETFs

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China Yuan ETFs Compared

FXCH becomes the third exchange-traded product to offer pure-play exposure to the Chinese currency; the two existing products have aggregate assets of close to $600 million. Those include:

WisdomTree Dreyfus Chinese Yuan Fund (CYB): This fund is an actively managed ETF that seeks returns reflective of both changes in the exchange rate and money market rates available in China. Unlike FXCH, CYB is a true 1940 Act ETF, a distinction that potentially results in more favorable tax treatment.

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Market Vectors Chinese Renminbi/USD ETN (CNY): This product is an ETN that offers exposure to exchange rate fluctuations. Generally, gains in currency ETNs are taxed as ordinary income.

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Click to Enlarge

Recent weeks have also seen the introduction of two China bond ETFs that offer exposure to the local currency. Guggenheim debuted its Guggenheim Yuan Bond ETF (RMB) last month, and was immediately followed by the Chinese Yuan Dim Sum Bond Portfolio (DSUM) from PowerShares. Both of those products offer exposure to bonds traded in Hong Kong that are denominated in the local currency.

See related: New Ways to Trade China’s Bond Market

The new CurrencyShares product charges an annual expense ratio of 0.40%, making it cheaper than both CYB (0.45%) and CNY (0.55%).

By Michael Johnston of ETFdb.com

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