INVESCO DB US DOLLAR INDEX BEARISH FUND

INVESCO DB US DOLLAR INDEX BEARISH FUND (UDN) Annual Report: A Look Back at the Year

This annual report provides a comprehensive review of the INVESCO DB US DOLLAR INDEX BEARISH FUND (UDN)'s performance for the fiscal year ended December 31, 2023. We will explore the fund's operations, financial results, and outlook to help investors understand its trajectory and alignment with their objectives.

Business Overview

The INVESCO DB US DOLLAR INDEX BEARISH FUND (UDN) offers investors a way to potentially profit when the U.S. dollar weakens against a basket of six major currencies: the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, and Swiss Franc. Conversely, the fund typically experiences losses if the U.S. dollar strengthens.

UDN achieves its objective by taking short positions in specialized financial contracts known as "DX Contracts," which track the U.S. Dollar Index. To support these positions and generate additional income, the fund holds U.S. Treasury bonds and invests in highly liquid money market funds. While these collateral holdings provide interest and dividends, the fund's performance primarily depends on the daily movements of the U.S. dollar against its currency basket. Invesco Capital Management LLC manages the fund.

Financial Performance

During the fiscal year ended December 31, 2023, the U.S. dollar generally strengthened against major currencies, driven by higher U.S. interest rates and a robust economy. Consequently, UDN, designed to perform inversely to the dollar, saw its net asset value (NAV) decline by approximately 8.5%. This outcome directly reflects the fund's inverse relationship with the U.S. Dollar Index, which posted a positive return during the same period. Total assets under management (AUM) reached approximately $150 million by year-end, influenced by both market performance and investor activity.

Unlike traditional companies, UDN, as an exchange-traded fund (ETF), does not generate "revenue" or "profit." Instead, its financial performance is measured by total return, which stems from the performance of its underlying DX Contracts and income from collateral holdings, less operating expenses.

• Total Return (NAV): The fund's NAV decreased by approximately 8.5% in 2023.
• Expenses: Operating expenses, encompassing management fees, trading costs, and administrative expenses, led to an expense ratio of 0.75% for the year. These costs marginally reduced the fund's overall performance.

Risk Factors

Investors should be aware of the following key risks associated with UDN:

1. Market Risk (U.S. Dollar Strength): The primary risk is the strengthening of the U.S. dollar. If the dollar appreciates, the fund will lose value.
2. Futures Contract Risk:
   • Roll Risk: Futures contracts have expiration dates, requiring the fund to "roll" its positions into new contracts. This process can incur costs (contango) or generate gains (backwardation), affecting performance. In 2023, roll costs modestly impacted performance.
   • Liquidity Risk: Although DX Contracts are generally liquid, extreme market conditions could hinder their ease of trading.
   • Counterparty Risk: The fund faces the risk that a counterparty to its futures contracts may default on its obligations.
3. Tracking Error Risk: The fund's performance might not perfectly mirror the inverse performance of the U.S. Dollar Index due to expenses, roll costs, and market inefficiencies.
4. Interest Rate Risk: Changes in interest rates can impact the value of the fund's Treasury bond holdings and the income from its money market investments.
5. Regulatory Risk: Changes in regulations for futures markets or ETFs could affect the fund's operations or strategy.
6. Concentration Risk: The fund concentrates solely on the U.S. dollar's performance against a specific currency basket, making it vulnerable to factors affecting this narrow market segment.

Management Discussion (MD&A Highlights)

In 2023, UDN's primary challenge was the U.S. dollar's sustained strength. This market trend directly opposed the fund's investment objective, resulting in negative returns. Managing "roll costs"—the expense of closing expiring futures contracts and opening new ones—also remained an ongoing operational consideration, though management strives to minimize their impact.

Despite the challenging market for a bearish dollar strategy, a key operational highlight was the consistent interest income generated from the fund's U.S. Treasury and money market holdings. This income partially offset some losses from the DX Contracts, underscoring the importance of the collateral management strategy. The fund also effectively tracked its inverse benchmark, minimizing tracking error.

Financial Health

UDN maintains a robust financial structure. The fund carries no traditional debt. Strong liquidity comes from its holdings in highly liquid U.S. Treasury bonds and money market funds, which also serve as collateral for its futures positions. This structure ensures the fund efficiently meets its obligations and redemption requests.

Future Outlook

Looking ahead, the fund's performance will largely depend on global macroeconomic trends, central bank policies, and geopolitical developments. Key factors influencing the U.S. dollar's strength include inflation rates, interest rate differentials between the U.S. and other major economies (e.g., the European Central Bank, Bank of Japan), global economic growth, and geopolitical stability.

Invesco Capital Management will continue monitoring these trends, as a weakening U.S. dollar environment would favor UDN's performance. While no significant regulatory changes specifically impacted the fund's structure or operations in 2023, the firm continuously monitors potential shifts in futures market regulations or ETF rules that could affect its operations.

Competitive Position

UDN holds a distinct position in the investment landscape, providing investors a straightforward way to express a bearish view on the U.S. dollar. The fund competes with other currency-focused ETFs (including those bullish or leveraged on the dollar) and direct foreign exchange (forex) trading. Its appeal stems from its accessibility and the ability to gain inverse dollar exposure through a regulated exchange-traded product, bypassing the complexities of direct futures trading or forex accounts.

Strategy

Invesco Capital Management LLC continues to manage UDN. The past year saw no significant changes in the fund's leadership or core investment strategy. The strategy remains consistent: passively tracking the inverse performance of the U.S. Dollar Index by investing in DX Contracts and holding highly liquid collateral.