Tuesday, November 24, 2009

DBV, An ETF For the New Carry-Trade: Analysis

By Seamus (guest post)

Remember the yen carry trade? It wasn’t that long ago, when Japanese investors gobbled up Uridashi Bonds. And yes, there was the mythical Mrs. Watanabe who handled the family finances. The popular tale was that Mrs. Watanabe was heavily into swapping Japanese Yen (JPY) for overseas investments, while her husband was toiling at work.

In reality, Mrs. Watanabe was a symbol for the hedge funds who borrowed JPY at virtually zero interest rate and bought a higher yielding currency like the NZD or AUD.

Well, today there’s talk of the USD carry trade as U.S. interest rates remain near zero. Basically one shorts the USD and goes long a higher yielding currency or invests in equities. So are we looking at a new Mrs. Watanabe with a name like Smith or Jones? No doubt it’s a different world.
Is there a carry trade ETF that can do this? Well, maybe “in essence,” per a source..

Let’s look at the Powershares DBV ETF, a fund that tracks the Deutsche Bank G-10 currency future Harvest index. Powershares states: “The Index is designed to exploit the tendency for currencies associated with higher interest rates to yield greater returns than currencies associated with lower interest rates.” Note the index is re-weighted quarterly.

The ten currencies in the fund are:

-United States Dollar, USD
-Euro, EUR
-Japanese Yen, JPY
-Canadian Dollar, CAD
-Swiss Franc, CHF
-British Pound, GBP
-Australian Dollar, AUD
-New Zealand Dollar, NZD
-Norwegian Krone, NOK
-Swedish Krona, SEK

What does the fund do?

It is a leveraged carry trade fund. Specifically, the fund invests on a 2:1 leveraged basis in long currency futures positions of the three different currencies which have high yielding interest rates and short currency futures positions of the three currencies which have relatively low yielding interest rates.

Now here’s the catch, per the latest Form 10Q:

“USD will not be one of the currency futures positions because USD is the Fund's home currency and, as a consequence, the Fund never can enjoy profit or suffer loss from long or short futures positions in USD.”

Interestingly, if the USD is associated with the highest or lowest interest rates, the leverage basis is 1.66:1

Of course, with the use of leverage the potential for both trading profits and losses increases.

So what currencies are the fund long and short?

Again, per the latest Form 10Q as of the close of business September 30, 2009, the fund was:



And since then, Australia and Norway have raised their rates, so no reason to believe there is any quarterly change on the long end.

What about today?

A call to the fund on November 20, 2009, disclosed the fund is currently balanced 3 long currencies (AUD, NOK, NZD) and only 2 short positions (JPY, CHF).


A representative stated the use of these three long currencies rise when the USD is weak while the other short currencies tend to strengthen when the USD is strong. Thus, with these three currency long positions versus the two currency short positions, the representative advised that currently “in essence the fund is short the USD.” So there can be differences in their rebalancing when the USD is one of the identified lowest or highest yielding currencies.

Performance :

DBV finished a negative - 28.78% for 2008. The fund was a positive + 5.96% in 2007. As of the close of the market on November 20, 2009, DBV is up @ 20% YTD. The fund has been on a steady rise since March. Note the downward path of the USD during the same time frame.

Other Facts:

The fund has made distributions in mid December the past two years.

DBV delisted from the AMEX to the NYSE ARCA as of November 24, 2008.
Powershares is owned by Invesco. The DBV ETF is managed by Deutsche Bank.


It is possible all long and short positions can all be profitable or all lose money.

A foreign investor may gain or lose depending on the performance of the USD compared to their home country currency.

One should be aware that hedge funds using highly leveraged carry trades closely monitor their positions and, on a moments’ notice of a possible fall in the value of their higher yielding assets, will reverse them.

Trading currencies can be very volatile and can result in significant losses. Please do your own diligence.

Current Interest Rates:

(Full disclosure: The author has no position in DBV)
About the author. Seamus is current Portfolio Manager and Consultant in security.
He has 30 years experience, including prior executive positions, and a strong financial investigative background.

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