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Alistaire

Exchange Traded Currencies: Sterling V Usd

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On evaluating the returns of the GBX (NOKP) & US$ (LNOK) versions of the ETFS Long NOK Short USD fund since inception, it seems that the UK version is net of the move in GBP/USD whereas the USD version accurately tracks the Long NOK Short USD trade.

As the ETFs Fact Sheet is not sufficiently detailed, can anyone explain how exactly the 2 currency variants are enacted in terms of the trades/cashflows that results in the widely different performance ?

eg If I go long the GBP listed Long NOK short USD ETF: so I pay in pounds, which are used to repo dollars that can be shorted & the proceeds used to buy NOK. On position liquidation, the NOK are sold, & the repo unwound, & FX'd back into sterling.

I can't work out when the FX's take place to either avoid or capture the GBP/USD exposure ? Or does the US$ variant suffer the final FX after the proceeds of the ETF sale are FX'd - hence it would not show up in the funds performance chart ? For a UK investor seeking to avoid Long GBP exposure & to short the USD relative to a strong currency (the NOK), it seems odd that the GBX version opens one to Long Dollar exposure & possibly so does the US$ variant ? How can one get the desired exposure ?

BTW - a previous poster had a similar question, but there's was NOT a currency ETF, & they noticed NO difference in returns...

Enlightenment would be very much appreciated !

A

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NOKP and LNOK are identical - the shares are equivalent (they have the same ISIN unique identifier). The only difference is that currency in which the price of the shares is quoted. LNOK is quoted in US$ and NOKP is quoted in £. As the shares are identical - any apparent difference in performance between the two, is simply due to changes in the USDGBP exchange rate.

When a share in this fund is created, the fund manager will take cash (US$) aside and hold it as collateral. They will then open a short USD, long NOK derivative position. On a daily basis, the currency position and collateral will be adjusted to keep a constant ratio (if the currency position has made a profit, then part of the position will be closed and converted into cash - if the currency position has lost, then cash will be used to extend the position. This rather perverse trade is needed so that the leverage of the fund remains constant - but has the disadvantage that it is massively wasteful as in effect every day the fund manager must either 'buy high' or 'sell low'). When the share is destroyed, the USDNOK position is closed, and profit/loss reconciled with the collateral, and the fund manager gets their cash back.

Because this is an ETF, shares are not created or destroyed for each purchase. They are created/destroyed when the supply and demand for shares are out of alignment. E.g. if there is strong purchase demand for the ETF by speculators, the price of the ETF shares can rise above their 'net asset value' (the total of the collateral and currency position). When this occurs, a market maker can create new shares (by opening a position and lodging collateral) and sell them for a small profit. The converse also occurs when selling demand on the fund is excessive, the price of the shares can drop below NAV - a market maker can then buy up the spare shares, and close the position releasing cash for a small profit. This arbitrage mechanism ensures that the price of the ETF shares tracks the value of the underlying currency derivatives with reasonable accuracy.

So, the key points with these funds is that:

a) The cash collateral backing the shares is in US$ (so when you buy such a share, you are converting a proportion of your cash into US$ - and therefore are short GBP, long USD)

B) In addition to the cash collateral, there is a levered derivative position (which is shorting US$, and going long NOK)

When you buy LNOK, the trade is completed in US$. E.g. you pay $50 for a unit of LNOK (which contains $45 cash, and a derivative which is $5 in profit). If you have a £ account with your broker, your broker will need to convert your funds to US$ in order to complete the transaction (which is priced in US$). When you sell, your broker will receive US$, and will need to convert to £.

When you buy NOKP, the trade is made in £. You pay £35 and receive a unit of LNOK (which contains the exact same $45 cash and a derivative $5 in profit). Because the transaction is in £, buying and selling does not incur any addition currency conversion fees.

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Many thanks for the detailed answer.

One further clarification & a question:

If all these USD backed currency ETFs deliver returns net of short GBP long USD, would I be correct in saying that in order to isolate the exposure that the name of the product implies eg to reduce a short GBP long USD ETF to a leverage of 1 or to isolate that Long NOK short USD exposure, that all would require a hedging Long GBP Short USD position, but that this would not be possible through using an ETF as each Long GBP Short USD ETF would cancel itself out implicitly for a GBP investor ?

Is there any way of using ETFs to achieve the desired exposures ? I'm looking to use ETFs as they allow currency trading within an ISA, in order to avoid the coming CGT hike.

Many thanks again,

A

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Is there any way of using ETFs to achieve the desired exposures ? I'm looking to use ETFs as they allow currency trading within an ISA, in order to avoid the coming CGT hike.

Not with the ETFs as available today. You would need a hedging position with a leveraged (2x or greater) short USD long GBP fund.

I appreciate that you aim to use these in an ISA in order to avoid CGT. However, currency ETFS (like other derivative ETFs) have the problem of 'slippage' (the buy high, sell low problem inherent to any such ETF, that gradually chips away at the ETF's value) as well as the problem of management fees, the financing charges (inherent in the currency derivatives used) and relatively high commission charges. The tax benefit of within-ISA trading is noted, but you should consider the much more transparent alternative of spread betting.

Spread betting uses a much simpler pricing structure and, depending on bookmaker, a far richer choice of currencies and other derivatives - the 'roll' (financing charge/profit) is more transparent, as are price movements. There is no 'slippage', no annual 'management fee' and the overall betting fee structure is often better than paying a fixed fee per trade. Spread betting also has the advantage of being completely tax-exempt, just like an ISA, without any limits on deposits into the account or exposures.

Edited by ChumpusRex

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Again many thanks for your the advice.

On further investigation, it appears that as spread betting is playing the market with a broker who's writing the prices, rather than directly trading with the market, that slippage is often huge & they do strange things with the spreads out of market hours so that any risk management stop losses can get knocked out when they shouldn’t have.

It looks like the equally tax free CFD's are closest to the market with the lowest slippage.

BTW - ETFS suggested that in the next few weeks they would be offering currency ETFs traded in GBP

Many Thanks Again

A

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Again many thanks for your the advice.

On further investigation, it appears that as spread betting is playing the market with a broker who's writing the prices, rather than directly trading with the market, that slippage is often huge & they do strange things with the spreads out of market hours so that any risk management stop losses can get knocked out when they shouldn’t have.

It looks like the equally tax free CFD's are closest to the market with the lowest slippage.

BTW - ETFS suggested that in the next few weeks they would be offering currency ETFs traded in GBP

Many Thanks Again

A

1. CFDs are not tax-exempt. They are fully taxed as income/capital gains as appropriate to your tax circumstances. They also have the disadvantage that they are not ISA compatible.

CFDs, however, are designed to replicate the experience and pricing structure of the underlying market - so as to give the impression that you are trading the actual market. Some CFD providers, even show you the real-time market order book, and will match that price - as if you were making the actual trade in the market.

However, what is actually happening is that you are contracting with your broker to pay/receive the difference due to your bet.

2. Spread betting is much the same as CFDs. You make an agreement with your bookmaker to pay/receive the difference due to a bet. The difference is that spread bookmakers use a simplified pricing structure - minimizing the complexity of dividend handling, etc.

The point with both CFDs and spread betting is that in both cases your bet is not with 'the market', but with your broker/bookie. They both control the price, spread, etc. The broker/bookie may choose to hedge your bet by placing the appropriate trade in the wider market - but that is their choice.

There is varying transparency between CFD providers and spread bookies. Some CFD providers go out of their way to provide transparency - several show you the exchange's order book, and allow you to place their hedging trade - they then give you the CFD based upon how that trade actually executed. Others are much less transparent.

Most CFD providers and spread bookmakers always hedge a client's bet. Some won't hedge if the client's bet is so small it isn't worth bothering.

It's worth having a look at some of the larger, more established bookmakers. They do tend to offer very aggressive market spreads and fees. In fact, I found that the big spread bookies actually offered tighter market spreads than big CFD providers (and that was even before the per-trade commission payable on the CFDs; the spread bets were 'commission fee' - i.e. the spread is the only charge).

I'd also be very wary of tales of woe from retail traders who have been burned on currency spread bets. The currency markets themselves often behave very unpredictably outside of normal market opening hours and can develop huge spreads - things like central bank currency interventions often occur out of hours, and can move currencies by several percentage points for minutes at a time, completely wiping out one side of the market. The fact that this is reflected in bookies' pricing streams isn't a conspiracy (indeed it shouldn't be as almost all bookies are 100% hedged in the market - even if they don't hedge every individual customer's bet - if multiple customers make the same small bet, they'll hedge the aggregate off - to do otherwise would be suicidal for the bookie). The thing is that retail spread betters tend to be gamblers using extreme leverage - while bookies permit such behaviour (as it is profitable for them) - to engage in such a trade is insanity.

If, as you suggest, you aren't intending to use this as a short-term speculative bet - then I really don't see the disadvantage of using a spread bet with very wide stop (or no stop if permitted by your bookie).

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  • 142 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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