Building a DIY Emerging Market Currency Index Portfolio

What is an Emerging Market Currency Index

An emerging market currency index combines multiple emerging market currencies according to specific rules and tracks their weighted average value. Compared to investing in a single emerging market currency, this approach provides diversification benefits and reduces individual country risk.

While institutional investors have access to specialized index products, retail investors must construct portfolios themselves. This article provides a detailed explanation of how to create an emerging market currency index using an FX account.

Benefits and Challenges of Emerging Market Currency Investment

Benefits	Challenges
High swap income from interest rate differentials	Significant exchange rate volatility risk
Low correlation with developed markets	Political and economic instability
Long-term growth expectations	Low liquidity
Diversification effect	Difficulty gathering information

Advantages of Index Investing

Diversified index-style investing rather than concentrated investment in individual emerging market currencies offers the following advantages:

Single-country risk diversification: Limits the impact of one country's crisis on the overall portfolio
Volatility reduction: Combining currencies with low correlation suppresses fluctuations
Rebalancing effect: Automates "buying low, selling high" through regular adjustments
Eliminating emotional decisions: Rule-based management maintains consistency

Existing Emerging Market Currency Indices

Before constructing a DIY index, it's important to understand the existing indices used by professionals.

JP Morgan Emerging Market Currency Index (EMCI)

One of the most widely referenced emerging market currency indices.

Composition: Major emerging market currencies from Asia, Latin America, Europe, Middle East, and Africa
Weighting: Considers GDP, trade volume, and liquidity
Base currency: US Dollar
Use: Benchmark for institutional investors

MSCI Emerging Markets Currency Index

A currency index linked to the MSCI Emerging Markets Stock Index.

Composition: Currencies of MSCI Emerging Markets Stock Index constituent countries
Weighting: Aligned with country weights in the stock index
Feature: Consistency with equity investments

Bloomberg Emerging Market Indices

An index covering a broader range of emerging market currencies, featuring comprehensive composition including frontier markets.

DIY Index Construction Method

Here's a specific process for retail investors to create an emerging market currency index using an FX account.

Step 1: Clarify Investment Objectives

First, clarify the purpose of index construction.

Investment Objective	Focus Points	Suitable Composition
Swap income focused	High-yield currency ratio	TRY, ZAR, MXN focused
Diversification focused	Low correlation	Regional diversification emphasis
Growth expectation focused	Economic growth rate	Asian emerging markets focused
Balanced	Risk-adjusted return	Equal distribution

Step 2: Confirm Available Currencies

Confirm emerging market currencies available for trading with FX brokers. Currencies available at major brokers include:

Region	Currency	Broker Availability
Asia	CNH (Chinese Yuan)	Many
Asia	THB (Thai Baht)	Limited
Asia	SGD (Singapore Dollar)	Many
Latin America	MXN (Mexican Peso)	Many
Latin America	BRL (Brazilian Real)	Limited
EMEA	TRY (Turkish Lira)	Many
EMEA	ZAR (South African Rand)	Many
EMEA	PLN (Polish Zloty)	Limited

Step 3: Portfolio Design

Design a portfolio from available currencies.

Recommendation: Compose with at least 5 currencies, keeping single currency allocation below 30%

Currency Selection Criteria

Here are the criteria for selecting currencies to include in the index.

Quantitative Criteria

1. Liquidity

Select currencies with sufficient trading volume and acceptable spread ranges.

High liquidity: MXN, ZAR, TRY (tight spreads)
Medium liquidity: CNH, PLN (somewhat wider spreads)
Low liquidity: Others (wide spreads, better to avoid)

2. Volatility

Check historical price volatility and reduce allocation to currencies with extremely high volatility.

Currency	Annual Volatility (Estimate)	Assessment
CNH	5-8%	Low volatility
MXN	10-15%	Medium volatility
ZAR	15-20%	High volatility
TRY	25-40%	Very high volatility

3. Swap Points

Swap income based on interest rate differentials is also an important selection criterion. However, note that high-yield currencies often carry higher exchange rate decline risk.

Qualitative Criteria

1. Economic Fundamentals

GDP growth rate
Inflation rate
Current account balance
Foreign exchange reserves
External debt ratio

2. Political Stability

Government stability
Central bank independence
Rule of law
Geopolitical risk

3. Structural Reform Progress

Fiscal consolidation efforts
Regulatory reform
Progress in internationalization

Weight Allocation Methods

How weights are allocated to each currency in the portfolio significantly impacts index performance.

Method 1: Equal Weight

The simplest method, allocating the same ratio to all currencies.

Example: For 5-currency composition, 20% each

Benefit: Simple, avoids concentration in specific currencies
Drawback: Doesn't consider economic size or liquidity

Method 2: GDP Weighting

Allocate weights according to each country's GDP.

Currency	GDP (Approximate)	Weight
CNH	$18 trillion	45%
MXN	$1.3 trillion	20%
TRY	$0.9 trillion	15%
ZAR	$0.4 trillion	10%
PLN	$0.7 trillion	10%

Benefit: Reflects economic size, appropriate exposure to major economies
Drawback: Risk of excessive concentration in China

Method 3: Risk Parity

Adjust weights so each currency contributes equal risk (volatility).

Formula: Weight = (1/Volatility) / Sum(1/Volatility)

Currency	Volatility	Inverse	Weight
CNH	6%	16.7	38%
MXN	12%	8.3	19%
PLN	10%	10.0	23%
ZAR	18%	5.6	13%
TRY	30%	3.3	7%

Benefit: Equalizes risk, suppresses impact of high-volatility currencies
Drawback: Complex calculation, reduces weight of high-yield currencies

Method 4: Mean-Variance Optimization

Calculate weights that maximize Sharpe ratio considering expected returns and risk.

Benefit: Theoretically optimal portfolio
Drawback: Risk of overfitting to historical data, complex calculation

Recommended Approach: Hybrid Method

Practically, a hybrid approach combining multiple methods is effective.

Base is equal allocation, halve weight for high-volatility currencies (TRY, etc.), set upper limit (25%) for low-volatility currencies (CNH, etc.)

Rebalancing Strategies

Regular rebalancing is essential for long-term portfolio maintenance.

Purpose of Rebalancing

Risk management: Prevents currency that has risen from becoming overweight
Disciplined management: Mechanical trading unaffected by emotions
Return enhancement: "Sell high, buy low" effect

Rebalancing Timing

1. Periodic Rebalancing

Execute rebalancing at fixed intervals.

Monthly: Increases transaction costs, potentially too frequent
Quarterly: Well-balanced choice (recommended)
Annual: Divergence may become too large

2. Threshold Rebalancing

Execute rebalancing when weight deviates beyond a threshold from target.

Deviation threshold: +/-20% of target weight (e.g., if 20% target, rebalance when outside 16-24% range)
Benefit: Reduces unnecessary trades
Drawback: Monitoring effort required

3. Hybrid Approach

A practical method: check quarterly, rebalance only if threshold is exceeded.

Points to Note When Rebalancing

Transaction costs: Consider spreads and commissions
Taxes: Tax implications from profit realization
Liquidity: Delay execution during unstable market periods

Practical Implementation

Here's a specific procedure for actually managing an emerging market currency index.

Necessary Preparations

1. FX Broker Selection

Select an FX broker meeting the following conditions:

Offers desired emerging market currency pairs
Tight spreads
Favorable swap points
Small minimum trading units (1,000 units preferred)

2. Capital Planning

Calculate appropriate position sizes.

Investment Capital	Leverage	Effective Position	Per Currency (5-currency composition)
$5,000	2x	$10,000	$2,000
$10,000	2x	$20,000	$4,000
$20,000	2x	$40,000	$8,000

Sample Portfolio

A specific composition example with $10,000 investment capital and 2x leverage.

Balanced Portfolio

Currency Pair	Weight	Estimated Position	Expected Swap (Annual)
MXN/USD	25%	$5,000 equivalent	~8%
ZAR/USD	20%	$4,000 equivalent	~7%
CNH/USD	25%	$5,000 equivalent	~2%
TRY/USD	10%	$2,000 equivalent	~20%
PLN/USD	20%	$4,000 equivalent	~4%

Overall portfolio expected swap yield: Approximately 6.9% (annual)

Record-Keeping Methods

Proper record-keeping is essential for long-term management. Record the following items:

Holding quantity and rate for each currency pair
Accumulated swap points
Rebalancing history
Overall portfolio valuation trend
Comparison with benchmark (such as USD)

Performance Evaluation

Regularly evaluate performance using the following metrics:

Total return: Exchange gain/loss + swap income
Sharpe ratio: Risk-adjusted return
Maximum drawdown: Maximum decline from peak
Benchmark comparison: Comparison with single currency or stock index

Creating a DIY emerging market currency index requires effort, but provides better risk diversification than single-currency investing. The key is to continue management based on consistent rules. Maintain a long-term perspective without being swayed by short-term market fluctuations, and manage your portfolio systematically.