Saturday, June 09, 2007

Currency ETF as a Defensive Fund

I've just discovered another new ETF which can act as a defensive fund. The Currency Harvest Fund (DBV) takes positions in 6 of the world's top 10 currencies based solely on their interest rates. It takes a leveraged bullish position (2x) in the 3 currencies with the highest interest rates, and takes short positions in the 3 with the lowest rates.

My understanding of why this works is that economies with high interest rates tend to attract foreign capital from people who want high-yielding fixed income investments, so those currencies tend to rise in value. Similarly, economies with the lowest rates tend to lose fixed-income investors. Since the fund takes positions in 6 currencies, a wrong move by one or two will not ruin the overall returns.

DBV already has an impressive track record of hanging with the S&P 500 in the long term while preserving its value through stock market corrections. Over the past 6 months, DBV (red) has actually outgained the S&P 500 (blue) by 2-1! (14% to 7%)

Impressive as that is, I'm more intrigued by what DBV did during the corrections. From February 20th to March 5th, when the S&P 500 lost 6% of its value, DBV lost only 3%.

In this most recent correction, the S&P was down by as much as 3% from its June 4th high, and today is down more than 2%. DBV has gained 1.5% since June 4th.

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