By Wisdomtree’s economic research team.
WisdomTree comments on how currency fluctuations impact ETF returns.
Investors looking to invest in ETFs may notice there are different currencies associated with the instrument. These currencies can have a significant impact on the return of the product, and therefore it’s important to understand how they work and why they fluctuate. This article seeks to offer some clarity to investors and traders around how currencies in ETFs work.
Firstly, it’s important to find out what index the ETF tracks and what currency that index is quoted in. For example, the NASDAQ 100 is quoted in USD, the FTSE MIB is quoted in EUR and the FTSE 100 is quoted in GBP.
Next, look at the base currency and net asset value (NAV). The base currency is generally the same as the currency the index is quoted in and the NAV is also typically quoted in the base currency. However, this is where it can get tricky: the ETF can also have a price or ‘indicative’ NAV which is quoted in multiple currencies.
This means that while ETFs are issued and redeemed in their base currency, they may be traded in multiple currencies and on different exchanges. Ultimately this facilitates trading and settlement by giving the investor the ability to buy the ETF efficiently through their own local exchange.
For example, a 3x short 10-year US Treasuries ETF has both its base currency and NAV in USD and trades in GBx and USD on the London Stock Exchange and EUR on the Borsa Italiana and Deutsche Börse Xetra.
ETF performance of a 3x short 10-year US Treasuries ETP on the Borsa Italiana
The return of each ETF will be different depending on the base currency of the ETF. It has its base currency and NAV in USD but quotes in EUR on the Borsa Italiana. In the table below, we show a hypothetical example indicating the daily movement of the NAV (in USD) for this ETF and include the daily change of the EUR-USD exchange rate.
The EUR price of the ETF is affected by both the change in the ETF’s price in USD and the EUR-USD exchange rate.
Source: WisdomTree.
In the above example over the four-day period, overall the NAV in USD was unchanged, while the EUR-USD exchange rate weakened from 1.15 to 1.10. This meant that overall while the NAV in USD was flat, an investor who traded in euros would have had an overall return of 4.5%, which was purely a reflection of the change in the exchange rate.
Looking at the hypothetical returns during the period, on Day 3 to Day 4 the NAV in USD fell by 4.8%, while the EUR-USD exchange rate rose by 4.8% from 1.05 to 1.10. The impact of this was to reduce the NAV in EUR from 100 to 90.91 resulting in a decrease of 9.1%.
This relatively simple example demonstrates that for an ETF where the underlying exposure has its NAV in a currency that differs from the listing currency, it is important to take note of both sets of returns.
Impact of currencies over time
The chart below shows the cumulative % change in NAV (USD) for the same ETF, alongside the EUR-USD spot rate and the NAV in EUR between December 2016 and September 2017.
As the USD strengthens versus EUR — in other words, it costs less USD to buy one EUR—the EUR-USD line moves down, while if the EUR strengthens versus USD — in other words, it costs more USD to buy one EUR — the EUR-USD line moves up. Over the period shown below, the ETF decreased by 6.06% in USD terms, while it decreased 16.3% in EUR terms as the USD weakened versus EUR by 12.1%.
Source: WisdomTree.
For this reason, if you invest in an ETF in a currency different to the currency of the ETF’s index, it is important that you are aware of the impact that movements in the exchange rate between such currencies can have on your investment.