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Can ETFs improve your currency hedging strategy?

As the exchange-traded fund industry grows, it's gaining interest from corporate treasurers attracted by lower fees, an alternative short-term investment and daily hedging possibilities.

Exchange traded funds (ETFs) are investment funds that can be traded on a stock exchange, much like stocks. Investopedia.com defines them “a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange.”

The ETF industry has seen a “stunning track record of expansion” in recent years, according to EY, which publishes an annual global ETF survey. Last year it predicted that the industry's assets under management (AUM) would reach $6 trillion by the end of 2020 (or above $7 trillion by 2021 according to this PwC report), growing from $ 3.4 trillion in August 2016. But data from Bloomberg has painted a less glowing picture, with a 13 per cent decrease of investments into European ETFs last year, although the European ETF market has seen a good recovery so far in 2017, with inflows up by $7.2 billion in the past 12 months.

Daily hedging with ETFs: effective but expensive

Pricing of ETFs typically fluctuates throughout the day as they are bought and sold and they have a higher level of daily liquidity and lower fees than mutual fund shares. This has been attracting corporate treasurers to invest in ETFs, using them as a hedging mechanism and as an alternative to other forms of short-term investment such as money market funds.

ETFs can be part of a daily-hedging strategy, in which currency exposure can be monitored and the hedge can be reset each day to reflect FX volatility. However, this article in Euromoney notes that this is an effective but expensive hedging option. 

Some of the key issues regarding ETFs for corporate treasurers to consider are summed up in this recent article in Treasury Today, which summarises two of the main factors:

  • You may need a brokerage account to trade ETFs – but not necessarily, as some brokerage companies offer implementation services to corporates.
  • Make sure you understand the ETF provider fully before beginning to trade – and understand the underlying assets of the ETF and how liquid the particular ETF is.

This item appears in the following sections:
Investing
Investing Short-Medium Term Surpluses
Money Market Fund Investing
Risk Management
FX Hedging & Risk Management

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