Saturday, May 13, 2006

DBV DB Currency Index Value Fund

Mick Weinstein, of seekingalpha.com asked me about the new DB Currency Index Value Fund (DBV). The DBV fund purchases treasury securities and uses them to purchase long futures with 2x leverage on the three G10 currencies with the highest interest rates. At same time the fund sells short, with 1x leverage, futures on the three G10 currencies with the lowest interest rates. Over time, it is expected that high interest rate currencies will become more valuable, and low interest rate currencies less valuable.

This exchange traded fund involves several concepts that are not my specialty and which I tend to avoid: these concepts are foreign exchange [FOREX] trading, using futures to speculate on forex, leveraging risky investments, and long/short strategies.

The problem with long/short funds, is that there is always a chance of the spread between the Long and short sides widening or staying the same. That widening on each side can produce two fold losses, before leverage. Investors like to say that It Can't Happen Here, but as the Nobel prize winning managers of Long term Capital Management found out, It Can Happen Here

I am not sure if investor's are psychologically prepared for volatile investments whose volatility increases with market stress. FOREX trading is very volatile. Most people aren't as risk tolerant as they think, and should view investing as being about risk avoidance and not risk tolerance. I'm not sure if people need, what Roger Nusbaum called a "high risk cash investment". A high yield money market account should be enough for most people. If they wanted foreign currency exposure, I think that a global floating rate income fund would be the best choice

Historically the currency convergence that Deutsche bank describes in the prospectus does occur. It is also possible that the convergence might not occur or even reverse under some sort of market conditions that have never been seen before. The collective history of the financial markets is very short, and unusual events occur much more often than would be expected.

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