What it means
An exchange-traded fund, or ETF, is a pooled investment that holds a basket of assets and is bought and sold during the trading day. A Euro ETF is simply an ETF with a euro angle.
The most direct version tracks the value of the euro against a currency such as the US dollar, so it rises when the euro strengthens. Other funds called euro ETFs hold European company shares or euro government and corporate bonds.
In these cases the investor is exposed to the performance of the assets and to the exchange rate when the fund is bought in a different currency. That double effect is easy to overlook until a currency move erases a gain.
For businesses and individuals, the appeal is convenience. A company with future euro expenses might use a currency-based fund as a rough hedge, and an investor can get diversified European exposure without opening foreign bank accounts.
The fund can be bought through a standard brokerage account. Costs deserve attention.
Each ETF charges an annual management fee, and the buying price and selling price differ by a spread. Currency funds that hold euro deposits may earn some interest, but the return mainly comes from exchange rate movements.
Some ETFs are currency hedged, meaning they try to remove the effect of exchange rates. A hedged European equity fund aims to deliver the return of the shares alone, whereas an unhedged one includes the currency move.
Reading the fact sheet is the only reliable way to know which you are buying. Finally, an ETF is not the same as holding physical euros.
It carries market risk, fees and tracking differences, and it is not a guaranteed store of value. A treasurer who needs certainty on a payment date will usually prefer a forward contract from a bank.
In practice
Real-world examples.
Example
A US importer expects to pay a European supplier in euros in six months. The finance manager buys a small amount of a euro currency ETF to partly offset the risk that the euro becomes more expensive.
Example
A retiree in Australia wants diversified exposure to large European companies. She picks an ETF that holds euro-area shares, and she checks whether it is hedged back to her home currency.
Example
A portfolio manager in Singapore thinks the euro will strengthen against the dollar over the next quarter. He buys a currency-tracking fund to express that view without trading in the foreign exchange market directly.
Formula
Calculation
Return from a currency-tracking Euro ETF = (ending euro exchange rate / starting euro exchange rate) - 1
Worked example: an investor puts $10,000 into a fund that tracks the euro against the dollar. At purchase, 1 euro is worth $1.05, and a year later it is worth $1.10. Ignore fees to keep the arithmetic simple.
Step 1: Change in the exchange rate = $1.10 / $1.05 = 1.047619.
Step 2: Return = 1.047619 - 1 = 4.76%.
Step 3: Ending value = $10,000 x 1.047619 = $10,476.19.
If the euro had fallen to $1.00 instead, the value would be $10,000 x (1.00 / 1.05) = $9,523.81, a loss of 4.76%.Case study
Seen in the real world.
Cedarline Trading is a fictional furniture importer in Chicago that buys from Italian workshops and pays in euros. Its finance lead worried that a stronger euro would raise costs on a large order due in four months.
She bought a euro currency ETF worth $200,000 as a partial hedge. The euro rose by 3%, so the fund gained about $6,000 while the cost of the euro order rose by a similar proportion, and the two effects largely offset.
In this illustrative case, the hedge worked, but she noticed that fees and the trading spread cut the benefit slightly. For future orders, Cedarline now compares the ETF with a bank forward contract, which fixes the rate for the exact amount and date.
Watch out
Common mistakes.
- Assuming every fund with Euro in its name holds euros, when some hold European shares or bonds instead.
- Forgetting that an unhedged fund adds currency risk on top of the risk of the underlying assets.
- Using an ETF as a perfect hedge for a specific payment, when tracking differences and fees can leave a gap.
Questions
People also ask.
Is a Euro ETF the same as owning euros?
No. It is an investment fund that tracks the currency or holds euro assets, and it carries market risk and fees.
How do I know whether the fund is hedged?
The fact sheet and prospectus state whether currency exposure is hedged, and they explain the method.
Can a company use a Euro ETF to hedge payments?
It can for rough protection, but a forward contract from a bank is usually more precise for a known amount and date.
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