ETFs are gathering assets amid the market malaise.
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By John Gabriel | 01-13-09 | 02:30 PM | Email Article

The performance of currency ETFs was all over the map during the course of the past year as we saw a massive unwinding of the carry trade--a popular hedge fund strategy where investors borrow in (or short) low-yielding currencies and invest (or go long) in higher-yielding currencies. The trick was that many of the hedge funds that crowded into this trade used excessive leverage in order to magnify the spreads they were earning. However, when the reality of the grim economic landscape set in (and commodity prices plunged through the floor), these hedge funds couldn't unwind their trades fast enough. Investor redemptions and margin calls greatly exacerbated this effect.

John Gabriel is a strategist on the passive funds research team for Morningstar and head of Canadian exchange-traded fund research.

In the end, the Japanese yen topped the charts, in terms of currency appreciation, thanks to the mad rush of hedge funds buying the yen to cover their short positions. The reverse was true for the commodity-based, high-yielding currencies that were used for the other side of this trade. In the desperate race to unwind the ubiquitous carry trade, hedge funds were forced to sell high-yielding currencies like the Aussie, New Zealand, and Canadian dollar, ultimately leading to a devaluation of these commodity-based currencies.

 Currency ETFs
 

2008
% Return

2008 Cash
Inflows (MM)
AUM
(MM)
CurrencyShares Japenese Yen Trust 
22.98
(451.874) 703.570
iPath JPY/USD Exchange Rate ETN 
22.90
(67.156) 12.951
CurrencyShares Swiss Franc Trust 
7.51
218.185 436.675
CurrencyShares Euro Trust 
-1.65
(239.663) 682.204
iPath EUR/USD Exchange Rate ETN 
-2.24
(89.311) 8.185
* Data as of 12-31-2008.

Through the malaise and credit crisis of 2008, U.S. Treasuries proved to be the save haven of choice for risk-averse investors. In fact, as investors fled for safety, the yield on the 10-year Treasury note fell to just marginally above 2%--the lowest level seen in more than 70 years. This is a testament to just how much fear was in the markets in 2008. Investors are willing to accept real negative yields on their money in exchange for the comfort of having the explicit backing of the U.S. government. With large banking institutions failing left and right over the course of the year, it's no wonder investors were hesitant to simply park their cash in the bank. Now, the question is whether Treasuries are in a bubble. We'd encourage investors to read Scott Burns' recent article on this topic, as we think this will continue to be a hot subject as we move through 2009.

 Fixed-Income ETFs
 

2008
% Return

2008 Cash
Inflows (MM)
AUM
(MM)
Vanguard Extended Dur Tre Index 
55.46
21.221 51.519
iShares Barclays 20+Yr Treas Bond 
33.77
(167.925) 1,892.624
SPDR Lehman Long Term Treasury 
24.14
(0.608) 25.409
PowerShares 1-30 Laddered Treasury 
21.82
69.150 99.137
iShares Barclays 10-20 Yr Treasury Bond 
20.10
58.174 169.224
* Data as of 12-31-2008.

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John Gabriel does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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