US Dollar Custodial Certificates (DCC)
South Africans now have a facility to invest directly in US treasuries through a new ETF on the market, US Dollar Custodial Certificates. Launched by RMB, the DCC invests in US treasury bonds (USTBs) and can be acquired through your stockbroking account but are not eligible to be included in tax-free savings accounts.
How does it work?
RMB acquires USTBs and holds them in a ring-fenced account. No index will be tracked, so RMB will use its discretion on which maturities to acquire. It then creates US dollar custodial certificates which are listed and sold on the JSE. During the investment period RMB will pay holders in proportion to their holdings an amount equal to the interest it receives on the USTBs, less 30 basis points on the face value of the USTBs. The payments will be made in rands. To ensure investors can sell their certificates speedily, RMB will ensure there is a liquid secondary market for these certificates.
What are the DCC’s growth drivers?
The returns from this ETF come from changes in the rand-dollar exchange rate, movements in the price of the USTBs as well as the periodic interest paid.
The price of USTBs fluctuates, tracking macroeconomic developments, monetary policy and the overall supply and demand on the market.
The monetary policy set by the Federal Reserve has a strong impact on USTBs prices. A rising federal funds rate tends to draw money away from bonds, causing the price to drop. A decline in the fed funds rate will have the opposite effect. Bonds also tend to drop when other investments seem less risky and the economy is in expansion. During economic downturns, investors often decide that bonds are the safest place for their money, and demand could spike.
With this ETF we think the rand-dollar exchange rate will be the major growth driver rather than the price movements of the underlying bonds. As shown on the graph above, an investment in dollars five years ago would have returned 11.16% a year in rand terms. An investment in dollars a year ago, on the other hand, would have lost 11.23%. These would have been the currency returns for DCC had it been in existence. Those returns surpass capital growth from the USTBs over that period.
Given the influence of the exchange rate on the performance of this fund we think it will best suit investors who have a negative view on the rand and believe that investing in dollars may preserve their assets.
The ETF will be exposed to risks arising from movements in financial markets. Movements in the rand-dollar exchange rate will affect the value of the USTBs and of the DCC. US macroeconomic factors, particularly the interest rate, will also have an impact on returns. The actual price will be determined by market conditions.
The key advantage with this ETF is that it enables companies and individuals to hold unlimited quantities of cash in US dollars. The DCCs are easily tradable, dollar-denominated investment instruments which have no exchange control implications.
One of the key gripes we have with this ETF is its lack of diversification. While its listing statement shows that it can invest in bonds with different maturities, RMB tells us that the fund will be holding only the 10-year USTBs for now.
The DCC is expected to have a total expense ratio of about 0.3% which we think is reasonably cheap.
There is no direct alternative to this ETF. Cash dollars or dollar futures traded on the JSE would be an alternative way to obtain a similar exposure. However, this ETF does provide an arguably more convenient way to obtain dollar exposure.
Background: Exchange traded funds (ETFs)
Exchange Traded Funds (ETFs) are passively managed investment funds that track the performance of a basket of pre-determined assets (in this case, US treasuries). They are traded the same way as shares and the main difference is that whereas one share gives exposure to one company, an ETF gives exposure to more than one company or instrument in a single transaction. ETFs can be traded through your broker the same way as shares, say, on the EasyEquities platform.
Benefits of ETFs
- Gain instant exposure to various underlying shares or bonds in one transaction
- They diversify risk because a single ETF holds various shares
- They are cost-effective
- They are liquid – it is usually easy to find a buyer or seller and they trade just like shares
- High transparency through daily published index constituents