Morningstar is out with a recent piece on various new currency ETF’s and a rather damning opinion of them.   I disagree with their conclusions.  I think currencies play a very important role in diversifying and reducing risk in ones portfolio.

Buying and holding currencies is a losing game.  No fiat currency has ever withstood the test of time (in the same manner as hard assets such as gold).   But as a hedging portion of ones portfolio I can’t stress how incredibly useful currencies are particularly for traders.  Not only that, but I would place currencies on the second rung of the financial instrument ladder in terms of importance (understanding debt is hands down the most important facet of understanding markets).  Ignore currencies and their important piece in the financial market puzzle at your own peril….

Understanding how a currency relates to other instruments can generate fantastic risk/adjusted returns.  For instance, last year anyone that understood the Yen carry trade generated incredible risk adjusted returns last year by holding Yen.  In addition, anyone who called for deflation last year and the likelihood of risk aversion and dollar demand (as I did) due to cash needs made great returns owning the dollar last year.

In addition, currencies are generally stable when compared to other assets.   Like many debt instruments, currencies are a great way to generate high non-correlated risk adjusted returns.   While the general message of this article is correct (don’t buy and hold currencies) I believe the hedging opportunities in currencies are incredible if you understand how each currency relates to other assets and the current market environment.   Anyone who tells you “cash is not a position” does not know what they’re talking about….

For more on currencies, diversification and risk adjusted returns please see here, here and here

Cullen Roche

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