A currency ETF, or exchange-traded fund, is a type of financial product that combines the best parts of stock and currency investment into a single product. Unlike foreign exchange market (Forex) trading, which is the traditional and somewhat complicated way to invest in currencies, currency ETFs can be bought and sold like common shares. As a result they are more accessible to the average investor. Specifically, currency ETFs are based on a combination of market and exchange rate performance as a way to reflect the value of one or more currencies.
A relatively new entrant in the financial marketplace, currency ETFs are part of the family of products known as ETFs, which are a sort of hybrid between the four main types of asset classes. These include stocks, bonds, commodities, and currencies. A currency ETF is designed to be flexible, like common stock, in the way that it can be bought and sold. At the same time, these products work like index funds, tracking the performance of selected corporations, currencies, or commodities.
The currency ETF of a particular currency tracks its value against others in combination with futures contracts, such as government bonds. Popular currency ETFs are based on currencies in emerging and fast-growing countries, like Brazil, India, China, and Russia. Funds exist, however, for just about every currency. For instance, if an investor were to look up FXE, which is the ticker symbol for the currency ETF based on the Euro, the result would be a snapshot of the Euro's value against other currencies worldwide. Some currency ETFs track multiple currencies as well, and reflect their combined performance.
Functionally, currency ETFs rely on a fund manager to select and aggregate a bundle of relevant currency products. In the U.S., the Securities and Exchange Commission (SEC) must approve a given currency ETF before it can be put up for sale. Once approved, investors can buy, sell, and conduct more advanced transactions with currency ETF shares, just like any other stock. Some of these more exotic trades include buying on margin and short-selling. This flexibility is not possible with Forex investing.
The currency ETF is somewhat unique as a financial product, in that, due to its partial reliance on exchange rates, it may not trend up naturally over time. Instead, investors can make money leveraging currencies as they gain and lose relative value. This makes them somewhat unattractive as part of a conservative, long-term investment strategy, versus regular money-market investing. For the savvy investor, they can make an attractive alternative to traditional investment products, however, that are tied to volatile real estate values.