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Are Currency ETFs Zero-Sum Speculation or a Hedge Against Risk?

In terms of currency-basket assets, WisdomTree dominates with its WisdomTree Emerging Currency ETF (CEW), which has $148 million in assets, and the WisdomTree Commodity ETF (CCX), with only $11 million in assets. A newer alternative is the PIMCO Foreign Currency Strategy ETF (FORX), which just started trading last February.

CEW seeks an equal-weight exposure to 15 emerging market currencies. Regionally, CEW allocates 46% to Asia, 26% to Latin America and 26% to Europe, the Middle East and Africa. CEW can pay a dividend but has not paid one since December 2011. Perhaps the most appealing thing about CEW from a diversification standpoint is its 0.25 correlation to the S&P 500, according to ETF Replay.

CCX offers roughly equal exposure to New Zealand, Australia, Norway, Brazil, Canada, Chile, South Africa and Russia. Similar to CEW, CCX can pay a dividend but has not done so in two years. Where CEW captures broadly positive trends in emerging markets, CCX is a mix of developed and developing countries that should benefit from positive trends in emerging markets.

Pimco's FORX is an actively managed fund that can also include short exposure. Currently FORX has 15% long exposure to Norway, 14% in Brazil and 11% in Mexico, and a 7% short position in Japan.

Over the last 12 months, all three funds have endured high single-digit losses. That certainly is off-putting.

But the currency markets have been distorted by global central bank policies. Investors have likely heard terms like competitive devaluation and currency controls, which indicate how central banks have shaped markets to prevent their respective currencies from rising.

In part because of competitive devaluation, most foreign equity markets have lagged U.S. equity markets.  That's of course a reversal from most of the last decade. When the pendulum swings back to favor foreign assets, then the currency funds will likely also rotate back into favor.

While now low prices in foreign currencies can certainly go lower from here, after several years of trending lower, there will at some point be a turn and foreign currencies will again move higher.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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