06 December 2008

Reader Question Regarding FXP

Reader Peter M complimented me on this post on FXP.

He then raised a question regarding the recent poor performance of FXP that has been taking its toll on both of our portfolios, asking if FXP is decoupled from the underlying FTSE/Xinhua China 25 Index.

I take very kindly to praise, and thought I'd tackle his question.

My quick answer is: FXP is doing a pretty good job returning 2X the inverse daily returns of FXI, the FTSE/Xinhua China Index Fund.

If FXP isn't tracking the FTSE/Xinhua China 25 Index, it's because FXI isn't fulfilling its aim to properly mirror its underlying index's returns.

I crunched some numbers on the spreadsheet below, starting on 20 November, when FXP closed at $93.00/share, and FXI closed at $21.16/share. Yesterday, FXP closed at $43.39/share, while FXI closed at $27.83/share.

Why the huge disparity? FXP tracks the 2X inverse daily returns of FXI. Over the past two weeks, FXI has had some wild swings, but where FXI has had one 5% loss and one 7.5% loss over that period, there have been single-day gains of 7%, 8%, 12%, and 16%.

Click to enlarge:

Barclays Global Investors operates iShares who manages the FXI ETF. ProShares, a competitor of iShares, manages the FXP ETF. ProShares has no control over the management of FXI. So should Barclehs receive some criticism?

The market volatility of the past few months has affected how well FXI correlates with the underlying FTSE/Xinhua China 25 Index, according to the following charts I created on Stockcharts.com.

This chart shows the daily correlation between the Index ($FXT) and FXI:

And this one shows the weekly correlation beetween $FXT and FXI:

The $FXT:FXI correlation levels have not returned to their pre-September levels, but they are getting closer to the long-term levels of ~440:1. It looks like iShares is trying to steady the ship in some very choppy waters. Still, at ~425:1, FXI is overvalued, compared to its underlying index.

FXI should eventually revert to the mean and fall in value, closer to the $FXT index.

Likewise, FXP should climb in value when that mean reversion occurs.

And that wouldn't suck for the portfolio.

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