Interest Rate Risks

The WisdomTree Dreyfus Emerging Market Currency Fund uses 90-day forward contracts to gain comparable exposure to money market rates in emerging market currencies. The fund collateralizes the contracts with U.S. money market securities.

"The advantage of 90 day forward contracts is that you limit the interest rate exposure," said Luciano Siracusano, chief investment officer at WisdomTree. 

Gaining this kind of short-term liquid exposure to a country's money market rates gives investors the least amount of interest rate and short-term inflation risks. However, in the long run, if inflation in an emerging market country becomes out of control, this would devalue its currency.

"Brazil's inflation rate is 5.5%. This is high for us but not for Brazil. Real Rates in Brazil are at 3.7%, making 3 month money yield 9.2%," according to Siracusano.

For Brazil, the effect of this kind of money market and currency combination exposure was "13.9% annualized from March 31, 1999 through March 31, 2009. The lion's share of this gain is coming from interest rates," said Siracusano.

This is an important statement about the features of this kind of investment. Returns are driven by the currency fluctuations and 90-day money market rates, which sometimes can be significant in emerging market economies, compensating investors for taking on the extra risks. 

The one-month deposit rates for the equally weighted basket of emerging market currency to U.S. investors, taking into account both rates and currency exchange, was 3.7 on 5/8/2009, according to WisdomTree. In context, the similar rate in the U.S. is .2% and .7% for both the euro and in the UK. The ranges of the one-month rates as of 5/8/2009 were Taiwan at -2.7% and Brazil at 11.2%. The currency exchange rates can be volatile and WisdomTree, on its Web site, posts the rates weekly.

How Active Is Active? 

This active ETF is really as passive as active gets. Each year, 8 to 12 emerging market currencies are selected for the fund for that next year. Currently, 11 currencies have been selected in the broad regions of Latin America, Europe, Middle East, Africa and Asia. The currency allocation then is equally weighted among the 8 to 12 currency exposures, and each quarter the fund rebalances back to this equal weighting.

The active portion of the fund is on the underlying security level, managing the investments used to meet the objective exposure to each currency, which is meant to be similar to holding money market securities in the respective emerging market country.

According to Siracusano, the emerging market currency ETF is active for two reasons. "Firstly, there was no relevant index and there is also a component of maintaining the flexibility to take action when needed from government involvement."

In short, the active part of this ETF is really from the unavailability of having an available index to track. The real active portion of the ETF is more akin to an administrative management of the forward contracts, something that WisdomTree alone has been able to do.  The objective of the fund is to represent the underlying money market rates. 

The investment committee for this fund meets annually and decides what countries are to be included. Considered are issues like low correlation among the currencies and region exposure, which needs to be "representative of the global emerging market economy. This means monitoring regional exposure, and liquidity of the underlying currency. This was why Russia was excluded this year; liquidity of the underlying currency was too low to effectively trade through forward contracts," according to Siracusano.

All in all, the WisdomTree Dreyfus Emerging Market Currency Fund is set to be competitive in the emerging market bond and emerging market currency category, both with relatively few competitors. Over the long run, currencies and short-term rates may be a smart way to play the significant growth potential in emerging markets while decreasing volatility and duration risks.

Kyle Waller is a research analyst at Wiser Wealth Management in Marietta, Ga. He welcomes comments and suggestions for future columns at:  This e-mail address is being protected from spambots. You need JavaScript enabled to view it .

1 | 2 |