China stunned the world last week as the country’s central bank devalued its currency to a four-year low against the US dollar, plunging 4.4% over the week. The impact has been felt across a range of markets. Exchange-traded funds tracking equities of countries which have significant export trade with China reacted negatively to the news, while those ETFs linked to Chinese exporters and the country’s A-share equity market more broadly responded positively. Other ETFs to benefit were those linked to so-called “safe havens” such as gold and US Treasuries.
Devaluation of the Renminbi has had an effect on asset prices right around the world.
Historically, the Chinese authorities have maintained a pegged exchange rate policy against the US dollar; however, the continued strengthening position of the greenback has resulted in the renminbi appreciating by 17% since mid-2014 to the end of July on a trade-weighted basis against a basket of currencies. This has had a detrimental effect on Chinese exports.
The three devaluations, which by no means may be the only moves by the monetary authorities, should see the export side of the economy revive itself and become a key driver of future growth.
There is another potential motivation behind the currency move. China is eager for its currency to be included in the ‘Special Drawing Rights’ of the IMF but has been urged to allow the currency to become more market-driven as a requirement for inclusion. Special Drawing Rights are a type of international asset held by the IMF which member countries have a claim to. They currently consist of the US dollar, euro, pound sterling and Japanese yen. Inclusion in this basket would add international recognition and prestige to the yuan. The devaluations have been viewed favourably by the IMF which decides in November whether to adopt the yuan.
The move to devalue the yuan three times in as many days has led some to believe this may be the start of a currency war between emerging market export-oriented countries. Further to this, some countries which are more closely tied to China through proximity or trade balances, such as Australia, South Korea or Japan, may see their currencies being depreciated against the US dollar by future moves, especially as expectation of a Federal rate rise should keep the dollar strong. As such, the foreign exchange markets are likely to be in a state of flux for the foreseeable future.
This changing dynamic in the FX markets could provide an opportunity to profit through ETF products that enable investors to adopt tactical positions in certain currencies – products such as the ETFS Short CNY Long USD ETC (SCNY), which provides exposure to an unleveraged short position in the Chinese yuan versus the dollar. This ETP gained 5.4% over the days of the devaluation last week and will continue to benefit if Chinese authorities undertake further devaluations.
Investors may also consider taking short and leveraged positions in other currency pairs likely to be affected by the currency dynamics. This can be achieved via ETPs such as the ETFS 3x Short AUD Long USD (SAU3) and ETFS 3x Short JPY Long USD (SJP3), which take triple leveraged short positions versus the dollar against the Aussie dollar and the Japanese yen, respectively.
As mentioned before, the devaluations should have a positive impact on Chinese exporters, and investors can gain exposure to this through the db x-trackers CSI 300 Industrials UCITS ETF (HK 3005). The fund was up 9.1% last week as of close on Thursday 14 August. The fund invests in large-cap industrial Chinese-listed companies, many of which are significant exporters.
The move has understandably had a negative impact on exporters of other countries as their products immediately less competitive with Chinese exports. This is particularly true of exporters in the South East Asia region, due to the close proximity of these markets with China as well as a similarity in the nature of their goods. The db x-trackers MSCI Malaysia Index UCITS ETF (XCS3), the MSCI iShares Thailand Capped ETF (THD), iShares MSCI Korea UCITS ETF (IKOR) and db x-trackers MSCI Indonesia Index UCITS ETF (XIDD) were all down last week.
Australia is also feeling the aftershock from the surprise move. Australia exports 30% of its goods to China and 40% of Australia’s exports are coal and iron ore, which will be affected by the slowdown in the country. The continued bear market in commodities and the realization that China’s economy will not expand as quickly as previously hoped have weighed on Australian ETFs. The iShares MSCI Australia UCITS ETF (SAUS) fell 3.2% on news of the devaluation.
Safe havens, however, have been a beneficiary of the devaluation as investors fear the devaluation may be indicative of the Chinese authorities’ concerns that the slow down in the Chinese economy may be more pronounced. In line with this, the ETFS Gold ETC (PHAU), one of the world’s largest gold ETPs, closed up 2.1% on Wednesday.
Long-dated Treasuries are another safe haven asset to have rallied following the devaluation. The yield on 10-year Treasury Bonds dropped from 2.24% at the start of the week to 2.15% on Wednesday. The iShares $ Treasury Bond 7-10 yr UCITS ETF (CBU0) traded up by 0.8% on Tuesday.
Whilst many investors have sought to trim their equity exposure on the back of the increased volatility, an alternative approach would be to instead partially de-risk within equities by allocating to smart beta ETFs that provide exposure to low volatility equities.
Simply put, low volatility ETFs typically invest in stocks that are less erratic than the broad market and which are optimally weighted to lower overall portfolio volatility whilst still offering access to the same underlying exposure. Such ETFs tend to offer investors a little more breathing room in more chaotic times and have performed relativity well on a risk-adjusted basis historically. There are a vast array of ETFs in this category. Examples include the Powershares S&P 500 High Dividend Low Volatility UCITS ETF (HDLV), the Ossiam FTSE 100 Minimum Variance UCITS ETF (UKMD), the iShares MSCI Europe Minimum Volatility ETF (MVEU) and the SPDR S&P 500 Low Volatility UCITS ETF (USLV).