Stay Hedged with the Yuan

05/01/2017 2:45 am EST

Focus: CURRENCIES

Kuen (Scott) Chan

Editor, Investing Daily's Real World Investing

The Trump-Xi summit resulted in diplomatic declarations of good will and a promise to keep dialogue open, explains Kuen Chan, global fund expert and contributing editor to The Complete Investor.

Despite a pre-summit tweet predicting a “difficult” meeting, and campaign threats to levy a 45 percent tariff on Chinese imports and label China a currency manipulator, Trump did nothing of the sort. In fact, Trump even stated afterwards that he and Xi were developing an “outstanding relationship.”

We view the lack of change to the trade relationship as a win for China, since China indeed holds the edge in trade, exporting three times more to us than we sell to it.

But China’s real impact stems from its incredible growth, and trade with China, even if tilted in China’s favor, benefits us far more than a trade or currency war, which at best would be a pyrrhic victory.

Our WisdomTree Chinese Yuan Strategy Fund (CYB) is a long-term hedge against the dollar weakening against the renminbi (RMB, aka the yuan).

This past year it has essentially treaded water as economic concerns led to major yuan outflows, pressuring the currency. Ironically, far from artificially devaluing the yuan, lately China’s policies have helped buoy it.

While no longer strictly pegged to the dollar, the RMB still doesn’t trade freely within China. Each day the People’s Bank of China (PBOC) sets a reference point based on the previous day’s close and in onshore trading lets the yuan fluctuate by up to 2 percent on either side of that midpoint.

But PBOC’s control has gradually loosened, with further easing likely. When the peg officially ended in 2005, the initial trading band was only 0.3 percent up or down. This expanded to 2 percent in 2014.

In August 2015, the PBOC changed its reference-point-setting policy to allow the previous day’s trading to determine the next day’s reference point, giving the market more influence in the yuan’s valuation.

And offshore the RMB does trade freely. The onshore and offshore yuan now tend to track each other pretty closely, with offshore yuan historically generally trading at a premium.

It is the Hong Kong offshore market on which WisdomTree trades and settles the yuan-denominated instruments — including money market securities, forward currency contracts, swaps, and others—with which it tracks the yuan’s performance.

The fund also strategically invests in short-term U.S. money market securities, forward currency contracts, and currency swaps in a way that mimics the yuan’s performance. WisdomTree Chinese Yuan Strategy Fund purpose as a hedge remains important. The fund is a buy up to $25.

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