Currency ETFs have currency as the underlying asset and trade like equity ETFs in centralised exchanges. The intent is to offer general investors low-cost, passive exposure in the currency market by investing in overseas currencies. These funds typically track one currency (or a basket of currencies) and its holding in a particular country or a group.

Understanding currency ETFs

The forex market is the largest globally. Currency ETFs offer a strategic exposure in the currency market through an investment portfolio.

Currency ETF is a pooled investment that tracks a foreign exchange and its holding across different markets, used for portfolio diversification. Investors seeking exposure in the currency market but dislike its highly speculative nature can gain exposure through currency ETFs. It is the perfect and the most economical way of investing in the FOREX market for retail investors.

For these reasons, the popularity of currency ETFs has seen a steep rise across various segments of investors. Usually, these funds invest in government securities and currencies as underlying assets, with Forex carrying the highest risk.

Forex can be highly volatile depending on economic conditions, political situation and interest rate. Hence, investors use them for speculation, hedging, and safety. Currency index fund managers try to meet the objective of the fund through investing in various investment options like cash, short-term bonds with currencies, and overseas currency derivatives contracts as underlying assets. Like mutual funds, currency ETFs invest in a pool of funds, offering investors a structured exposure in the foreign exchange market. Investors can trade currency index funds through a managed portfolio like a regular ETF for economic and seamless access to the global currency market. Some of these funds are guaranteed by foreign currency deposits, while others are not. So while investing in currency funds, investors need to make a careful selection based on their appetite and ability to mitigate risk.

However, it is crucial to recognise that investing in currency index funds will carry higher risk because of the volatile market. Investors trade foreign currencies in speculative trades on spot exchange rates.

Trading at a spot rate is the best method to invest in the Forex market. The rate keeps fluctuating depending on the currency’s demand against another currency or a basket of foreign exchanges. Currency fund managers, therefore, add a few investing strategies to maintain the performance of the fund.

Key takeaways

– Currency funds offer low-cost, easy access to the vast foreign exchange market to general investors.

– Earlier, the market was considered only for large and experienced investors. But currency ETFs have made it possible for small investors to invest in the currency market.

– Currency funds offer a higher degree of diversification, but these also carry high risk because of the volatile nature of the underlying.

– Fund managers often mitigate risk by adopting various strategies, including different products of varying risks.

– Basket investment means investing in a bouquet of currencies. It offers stability to the investment than investing in currency-specific funds.

– Currency ETFs rank higher on the riskier side because of the highly volatile nature of the underlier. Fund managers perform primarily to mitigate the risk.

– Besides changing rates, currency prices are also influenced by political and economic events.

Conclusion

Currency ETFs are indeed riskier investment products. Forex trading carries unique risks. But at the same time, it offers exposure to the highly efficient Forex market. ETFs can help improve portfolio returns through foreign currency exposure.