The Fall of EM Currency ETFs: Too Far Too Fast?

A suddenly strong U.S. dollar is claiming rival currency victims throughout the emerging world. Earlier this week, the Indian rupee touched a record low against the greenback. Forwards on the Indonesian rupiah fell to multi-year lows and the currency has weakened so dramatically, so rapidly in Southeast Asia's largest economy that the central bank there raised interest rates today.

Apparently, emerging markets currencies do not like the May-June time frame. In 2012, May was the worst month of that year for developing world currencies as investors bid the dollar up due to concerns about Europe's sovereign debt crisis. In fact, last year's decline in emerging market currencies was, at the time, the worst since 1998 during the Asian sovereign debt crisis.

It is hard to say things look any better this year. Actually, the situation might look worse. For example, WisdomTree Indian Rupee Fund (NYSE:ICN), which tracks a currency some view as undervalued relative to the dollar, has tumbled five percent in the past month.

But before investors rush to further repudiate bahts, pesos, reals, rupees, rupiah and others, they may want to consider if the punishment these currencies have recently endured is too much too soon.

"In May 2013, we believe investors should not confuse a broadly stronger dollar with an anti-EM position," said WisdomTree Portfolio Manager Rick Harper in a new research note. "With some positive economic surprises in the U.S. and some concerns in emerging market countries such as South Africa and Turkey, we believe the market has moved too far too fast."

There might be something to that assertion. Consider the fate of the WisdomTree Dreyfus Emerging Currency ETF (NYSE:CEW), an ETF comprised of "Mexican Peso, Brazilian Real, Chilean Peso, Colombian Peso, South African Rand, Polish Zloty, Russian Ruble, Turkish New Lira, Chinese Yuan, South Korean Won, Indonesian Rupiah, Indian Rupee, Malaysian Ringgit, Philippine Peso and Thai Baht," according to WisdomTree.

CEW allocates weights to those currencies ranging from 6.38 percent to the rand at the bottom to 6.95 percent to the zloty at the top. In other words, this is basically an equal-weight ETF and equal-weight does not always work when a significant percentage of the fund is being taken task.

No one should feel sorry for the ETF, but this is what CEW has had to deal with in recent weeks: Labor strife in South Africa, anti-government protests in Turkey, the baht and Philippine peso falling to new 52-week lows against the dollar, the rupee's record low and the Brazilian real hitting a four-year low.

Those currencies combine for about 38 percent of CEW's weight and they have all been hampering the fund at the same time, a rare set of circumstances, but one that might spell opportunity.

"Ultimately, we believe this moderation in performance could be a long-term buying opportunity for income-minded investors. Although this time may indeed be different, we believe that allocating a portion of investor portfolios to emerging market currencies and debt could serve as a means of diversifying risk and enhancing yield over the longer term," said Harper.

Before running to sell emerging markets currencies right now, remember that after June 2012, 11 of 18 major developing world currencies finished the year noticeably higher. CEW gained almost 10 percent from June 2012 through January 2013.

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