These ETFs Go To 11

New leveraged funds open interesting trade possibilities.

VelocityShares launched a suite of currency ETNs that offer 4X leverage for trading the US dollar against the Australian dollar, Swiss franc, euro, British pound and the Japanese yen both long and short. For example, DAUD bets on the US dollar against the Aussie, while UAUD bets on the Aussie against the greenback.

These are not as crazy as they might first appear, far from it actually. Currency traders use much more leverage than 4X trading for pips, fractions of a penny. I would expect these funds will be less volatile in the short term than most of the 2X equity funds and certainly any 3X equity funds.

That doesn’t mean they can’t go down a lot. In 2014 the US dollar went up 10% against the Swiss franc. In simple terms the fund that went long USDCHF would have gained 40% while the fund that went long CHFUSD would have declined 40%. I say simple terms because they reset daily.

Just because they are unlikely to be anywhere near as volatile as something like the Direxion 3X Junior Gold Miner ETF (JNUG) doesn’t mean they would be suitable for the typical investor.

To the extent currencies, regardless of leverage or not, have any role in a diversified portfolio; what is the allocation decision? Stocks, bonds and cash. If you would consider foreign exposure to equities and fixed income, then why not cash?

When I first became aware of Nassim Taleb a while back I was intrigued by once concept he espoused at the time which was to have 90% of your portfolio in t-bills from various countries and then be very aggressive with the other 10%. T-bills obviously don’t have much if any volatility and spreading around the currency would hopefully offset adverse currency movement.

If the aggressive 10% doubled in a year (huge assumption of course) and the global t-bill allocation returned 1.5% maybe to 2.5% then the overall return would exceed 10% which on a risk adjusted basis would be very good.

It’s fascinating but difficult to access and not very practical. Being right about the aggressive 10% could go badly just as often as it goes well. Owning 90% in a bunch of different currencies, whether that included the US dollar or not, probably wouldn’t work for US based investors. The dollar tends to go years at a time being weak against most currencies (like in the 2000’s) and then years at a time being strong against most currencies like the current decade.

This year of course the dollar has generally been weak and it wouldn’t be a surprise if we are now in the early stages of the pendulum swinging back to dollar weakness. This makes the case for foreign equities or increasing exposure to foreign equity to capture the currency tailwind, this worked very well in the last decade.

The actual currency market tends to be a little more complicated. For the last three years the Bank of Japan and the Swiss National Bank have both been desperately trying to devalue their respective currencies without much success where the greenback is concerned. The dollar is down against the yen by about 5% and the dollar is up ever so slightly against the franc. While the US dollar may not be the target of the SNB if you’re a US based investor that is relevant.

I am intrigued by these funds even if I am unlikely to use them for clients. Of most interest would be the UAUD which goes long the Aussie not so much as a short term bet but Australia as a commodity based economy has more potential to offer diversification against a service based currency like the dollar, or the euro or the yen.

For someone looking use this as part of a hedge or other sort of combo, there is no shortage of sophisticated ideas, it bears remembering that leverage can either be used to increase speculation or get more bang for the buck by investing less in nominal terms which if done correctly would improve the risk adjusted return.