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How currency movements can impact ETP returns
Constructing a portfolio with a mix of domestic and international assets has never been easier due to the wide range of Exchange-Traded Products (ETPs) that are now available to investors on exchange. However, when investing in ETPs, it’s important to realise that you could be exposed to currency risk, as currency movements can have a significant impact on ETP returns.
In this article, we’ll explain how currencies in ETPs work and look at how currency movements can affect ETP returns.
Multiple currencies
If you’re interested in investing in ETPs, you may have noticed that there are often different currencies associated with the same ETP.
For example, an ETP tracking the S&P 500 – an index that is quoted in US Dollars – could be traded on the London Stock Exchange in Pound Sterling. The reason that ETPs are often traded in multiple currencies and on different exchanges across the world is that it provides investors with the opportunity to buy ETPs efficiently through their own local exchanges. While this is an advantage for investors, multiple currencies also introduce currency risk.
Understanding the risk
When it comes to understanding ETP currency risk, the first step is to determine where currency exchange rates can have an impact on the product valuation, and thus on performance calculation.
- Investor’s currency: in what currency do you calculate your overall performance?
- Trading currency: what currency does the ETP trades in?
- NAV currency: what currency is the ETP’s NAV (Net Asset Value) calculated in?
- Underlying components trading currencies: what is the trading currency of the portfolio constituents?
Assuming an exact same composition between the underlying index and the ETP, when comparing the underlying index performance with the performance experienced by investing in the ETP, you must realise that:
- The constituents trading currencies is the same in both the index and the ETP
- No currency impact here at this level
- The ETP’s NAV and trading currency, as well as the investor’s currency can be different from the index calculation currency
- Can have currency impact on performance calculation
As an example, a EUR investor wants to buy a 3x short 10-year US Treasuries ETP on Borsa Italiana. She buys an ETP trading in EUR, while its NAV would be computed in USD, and the underlying instrument (10-year US Treasuries) trading currency would also be in USD.
Once you know the currencies that you are dealing with, you can analyse how currency movements may affect performance. This investor would then be penalised by USD depreciation as it would erode the EUR value of the ETP. On the other hand, she would benefit from USD appreciation.
Here’s an example of how currency movements could impact the returns from a 3x short 10-year US Treasuries ETP traded on the Borsa Italiana.
Currency impact on performance: An example
In Figure 1 below, we present a hypothetical example that shows the daily movement of the ETP’s NAV in US Dollars, as well as the daily change in the EURUSD exchange rate. The NAV currency of the ETP is the US Dollar, but as it’s listed on Borsa Italiana, it’s traded in Euros.
Figure 1. ETP NAV movements and EURUSD fluctuations
Source: WisdomTree, illustrative example. You cannot invest in an index. Historical performance is not an indication of future results and any investments may go down in value.
The table shows that the Euro NAV price of the ETP is affected by both the change in the ETP’s NAV price in US Dollars and the EURUSD exchange rate.
Over the four-day period, the NAV in US Dollars was unchanged overall, i.e. 0.0% performance in USD. However, over the period the USD appreciated from 1.15 to 1.10 USD per Euro, so an investor who purchased the ETP in Euros would have seen an overall return of 4.5% (€90.9 end value vs. €87.0 start value), as a result of the change in the exchange rate.
Impact of currency movements over time
Figure 2 below shows how currency movements can have a significant cumulative effect over time, looking at the performance of that same 3x short 10-year US Treasuries ETP.
Figure 2. Currency moves can have a significant impact on returns: 2017 example
Source: WisdomTree, Bloomberg. You cannot invest in an index. Historical performance is not an indication of future results and any investments may go down in value.
As you can see, the cumulative NAV return in US Dollars was -5.5% over the period. But a significant depreciation of the USD vs. the Euro resulted in a NAV return in Euros of -15.0%, a considerable 9.5% return difference.
Summary
Whenever investing, currency is likely going to have an impact on your portfolio’s performance, unless underlying, NAV, trading and reporting currencies are all the same. Understanding where this impact lies is important, as it allows you to better understand the potential risks arising from currency exchange movements, which can significantly support or dampen returns.
Crypto assets have been approached with caution by some investors given their volatility during periods of market stress and this year has reflected this perspective, as crypto has struggled amid macroeconomic uncertainty.
However, as we highlighted in previous editions of the Hash Insider, maintaining exposure is critical across most asset classes — for example, missing only the 10 best days in the S&P 500 over a 20-year period would significantly reduce your overall returns. In crypto, this effect is even more pronounced: missing the 10 best days can actually turn a positive performance into a negative one.
Once again, following a new wave of crypto-related tailwinds, such as the recent withdrawal of the crypto guidance for banks by the Federal Reserve, crypto has demonstrated resilience, recovering from the shock of Trump’s “Liberation Day” much faster than other asset classes.
We have seen this pattern before, and it reinforces the idea that stress events could present valuable investment opportunities in the crypto space.
Market Highlights
Federal Reserve withdraws crypto guidance
The Federal Reserve has withdrawn previous guidance that discouraged banks from engaging in crypto activities such as custody and trading.
This move, part of a broader regulatory shift under the Trump administration, is poised to foster innovation in the crypto space by reassessing regulatory frameworks and easing restrictions.
SEC advocates for clear crypto regulations
SEC Chair Paul Atkins has emphasized the need for a robust regulatory framework for digital assets after taking office last week.
This highlights Atkins effort to provide clarity and stability in the marketplace, signaling a significant shift in the SEC’s approach to the growing digital asset sector, the effects of which should be beneficial to the whole asset class throughout the current administration.
US BTC ETFs record $3.1B in weekly inflows
Spot BTC ETFs in the US have recorded a new weekly inflow record of $3.1 billion, driven by investor enthusiasm amid BTC’s recent price surge.
This marks the seventh consecutive week of positive flows, underscoring the growing institutional interest in BTC as it once again nears $100,000.
Market Metrics
The NCITM constituents had a strong week, with most constituents posting gains close to or above 10%. This week’s highlight was ETH (+14.0%), which, after several weeks of underperformance, outpaced both BTC (+11.6%) and SOL (+9.5%), contributing significantly to the NCITM’s 11.6% return. This shift could signal a broader turnaround in crypto performance, supported by even stronger fundamentals following the withdrawal of crypto guidance by the Fed, and the endgame of the tariff war by Trump.
This week, the NCITM (+11.6%) delivered strong performance, nearly doubling the gains of traditional indices like the Nasdaq 100 (+6.4%) and the S&P 500 (+4.6%). This surge allowed the NCITM to close the gap and finally surpass the Nasdaq 100 on a year-to-date basis. As we’ve discussed in previous editions, crypto fundamentals remain strong and strengthening, with the setback of the past few months being mainly due to macroeconomic headwinds. This week could mark the beginning of a shift, with those headwinds weakening and fundamentals weighing heavier on the positive side.
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