What is FXA? (Pros, Cons, and Strategies)

Investing in foreign currencies can be an exciting and potentially rewarding approach to diversifying your investment portfolio. One popular option within this space is FXA, the Invesco CurrencyShares Australian Dollar Trust. FXA offers a way for investors to gain exposure to the Australian dollar. Today, we will explore what FXA is, along with its pros, cons, and some strategies for investing.

What is FXA?

FXA is an exchange-traded fund (ETF) that aims to track the price of the Australian dollar relative to the U.S. dollar. Essentially, FXA provides investors with an opportunity to hedge against or speculate on the movements of the AUD/USD currency pair.

Key Features of FXA

• Physical Currency Holdings: FXA holds actual Australian dollars in a financial institution, giving direct exposure to the currency.
• Daily Expense Ratio: The fund charges an expense ratio of approximately 0.40% per year, which is relatively low for currency ETFs.
• Liquidity: FXA provides liquidity and is traded on the New York Stock Exchange (NYSE).

FXA Composition

FXA simply holds Australian dollars. This straightforward composition means that its performance is directly tied to fluctuations in the AUD/USD exchange rate. The trust does not invest in any other assets, derivatives, or financial instruments.

Pros of FXA

Diversification

FXA provides a unique diversification opportunity. By investing in a non-U.S. currency, investors can hedge against a decline in the U.S. dollar. This can be particularly advantageous during periods of dollar weakness or rising inflation in the U.S.

Easy Access to the Currency Market

For individual investors, directly trading foreign currencies can be complex and costly. FXA simplifies this process, providing easy access to the Australian dollar without the need for a forex trading account.

Inflation Hedge

The Australian dollar has historically shown resilience during periods of commodity price inflation due to Australia's significant export of commodities like iron ore and gold. This characteristic can provide an inflation hedge for investors holding FXA.

Cons of FXA

Currency Risk

Investing in FXA comes with inherent currency risk. The value of the Australian dollar relative to the U.S. dollar can be highly volatile, influenced by various factors such as interest rates, economic data, and geopolitical events.

Lack of Yield

Investors in FXA do not earn interest or dividends. The fund's performance solely relies on the appreciation of the Australian dollar, which can be disadvantageous compared to other income-generating investments.

Expense Ratio

While FXA's expense ratio is relatively low for a currency ETF, it is significantly higher compared to equity ETFs like SCHD. Over time, these fees can erode returns, especially in a low-yield environment.

FXA Investment Strategies

Investing in FXA requires a thoughtful approach given its unique characteristics. Here are some strategies to consider:

Short-term Trading

For investors looking to capitalize on short-term movements in the AUD/USD exchange rate, FXA can be an effective tool. Monitoring economic indicators such as interest rate decisions by the Reserve Bank of Australia (RBA) and U.S. Federal Reserve can provide insights into potential currency movements.

Diversification Strategy

FXA can be used as part of a broader diversification strategy. By allocating a small portion of your portfolio to FXA, you can reduce overall portfolio risk and hedge against potential declines in the U.S. dollar.

Inflation Hedge

For investors concerned about inflation, especially due to rising commodity prices, FXA offers a potential hedge. Australia's economy is heavily tied to commodity exports, so the Australian dollar may benefit during periods of commodity inflation.

Hedging International Exposure

If you have investment exposure to Australian assets, such as Australian stocks or real estate, FXA can be used to hedge against currency risk. This can help protect your international investments from unfavorable exchange rate movements.

Conclusion

FXA, the Invesco CurrencyShares Australian Dollar Trust, provides a straightforward and accessible way to gain exposure to the Australian dollar. While it offers unique benefits such as diversification and an inflation hedge, it also carries significant currency risk and lacks yield. Investors must carefully consider their risk tolerance and investment objectives when incorporating FXA into their portfolios. By employing strategic approaches, FXA can serve as a valuable tool for both short-term and long-term investment horizons.