How to diversify out of sterling

Exchange-traded currencies (ETCs) are a great way to gain exposure to foreign currencies, whilst avoiding expensive bank dealing spreads. Paul Amery reports.

US equity-market volatility is, for now, back down to pre-crisis levels. Meanwhile, interest rates are pegged at near-zero in many major economies, and central banks are propping up bond markets through quantitative easing. But with all these artificial support measures underpinning equity and bond markets, volatility is increasingly likely to erupt elsewhere. Right now, some of that pent-up pressure is being released in the currency markets.

The US dollar has shot up against the Japanese yen by nearly 25% in six months. Sterling has dropped by 10% against the US currency since the start of the year. The euro has recently lost its shine too, topping out at $1.37 as recently as 1 February. This week it fell to below $1.29, in the aftermath of the Cyprus government's attempted raid on savers.

While the Cypriot parliament rejected the deal, it's got people right across Europe thinking long and hard about the safety of money held in a bank. But if you're sitting on money in a British bank account, you're probably also wondering what you can do to protect yourself against the efforts of the government and the Bank of England to devalue your savings.

In theory, EU member states have promised that deposits in banks are covered by government insurance schemes up to a minimum of €100,000 per saver, per bank. In Britain, £85,000 is covered in this way by the Financial Services Compensation Scheme. But, as we've seen in Cyprus, the rules can change in a hurry. And neither guarantee protects your money from being eroded by inflation.

So what if you're looking for exposure to a different currency? Shifting money from one currency account to another at your bank typically incurs a minimum 1.5%-2% dealing spread. An alternative option is to use ETF Securities' currency products.

Exchange-traded currencies (ETCs) offer a way to diversify beyond sterling, but in a more flexible way than just switching from pounds to dollars at your bank. An ETC can allow you to go long dollars against the euro via an instrument that's priced in sterling, for example (using the ETF Securities Short EUR Long USD ETC (LSE: SEUP)).

There are two costs to consider: the bid-offer spread on exchange and the carry cost' of the ETC. This ranges from 1% in ETCs tracking G10 currencies to 1.5%-2% in the emerging-market currency trackers and leveraged versions.

Paul Amery edits www.indexuniverse.eu, the top source of news and analyses on Europe's ETF and index-fund market.

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