A Fund that Gains from a Falling Dollar
If you're down on the dollar, you're not alone. With deficits looming and uncertainty about how much the U.S. economy will slow, more investors are shunning dollar-denominated assets. "The pressures on the dollar aren't going to go away," says Axel Merk, manager of the $50 million Merk Hard Currency Fund (MERKX).
Merk's fund, just 18 months old, is part of a new breed of currency investing (see BusinessWeek.com, 12/25/06, "Currencies: Don't Let the Dollar Get You Down"). The Palo Alto (Calif.)-based Merk Hard Currency Fund holds a basket of currencies—including the euro, Swiss franc, and Australian dollar—and goes up when the U.S. dollar falls. It also holds gold. Unlike other so-called hard currency funds, it doesn't hedge or use leverage. So far this year through Dec. 28, the fund is up nearly 11.1%.
Merk favors the euro and conservative currencies in Europe and stays away from Asian currencies, which he feels are more speculative and carry more risk. The recent market swoon in Thailand is one reason he thinks it's better for long-term investors to focus on stable European economies rather than speculate on emerging ones (see BusinessWeek.com, 12/19/06, "Emerging Markets Turmoil").
BusinessWeek.com's Karyn McCormack met with Merk in New York on Dec. 13 and discussed his fund and what's next for the dollar. Edited excerpts from their conversation follow.
What's your outlook for the dollar?
The dollar is more on people's mind because of the sharp moves. And more recently, after the election, the dollar declined significantly. It didn't matter whether Democrats or Republicans would win—what mattered is that with the elections over, what will happen over the next year or two years. Focus went back to the big picture issues: the big deficits such as the trade deficit, current-account deficit, the budget deficit. Those issues aren't going away, and they make the dollar quite vulnerable.
We have a current-account deficit of over $800 billion. The current-account deficit is the amount that foreigners need to buy in U.S. dollar-denominated assets for the dollar not to go down. We don't need foreigners to sell the dollar for it be under pressure, they just have to buy less. And they have been doing that, because it's in their interest to sell to American consumers.
The problem is, if and when the U.S. economy slows down—and it's slowing down now—will foreigners be as inclined to buy as many dollars as they have in the past, especially if there are opportunities elsewhere in the world that are very attractive, or if we make it more difficult for foreigners to invest through regulation or other things that may scare them away?
Which currencies does your fund own?
We focus more on the conservative currencies, such as the euro, Australian dollar, and Canadian dollar. In particular, Europe has become an anchor of stability. Over the last year, for example, the euro has done extremely well, whereas the yen has significantly underperformed, and that has come as a surprise to many people. I think we were the only ones a year ago who were negative on the yen.
How does your fund work? How do you profit from moves in the dollar?
At the Merk Hard Currency fund, we invest in a basket of hard currencies. That means when we get inflows, we buy the euro, the Swiss franc, the Australian dollar, and Canadian dollar and the like, and in those currencies, we buy money-market instruments. So we try to get some interest in those currencies and then pass that on to investors.
What the investor gets is the fluctuations of those currencies vs. the dollar. So as the dollar declines, the investor can make money. In a flat market, we try to pass on some interest, net of expenses, and when the dollar rises, the fund can lose some value.
What about emerging markets?
I stay away from currencies that many are pounding as having wonderful potential. The story is quite straightforward. Asia is very much dependent on exports to the U.S. And now, U.S. growth is slowing down, and if at the same time, you have upward pressure on currencies in Asia, it's a double whammy on the economies there.
We're underestimating the types of dislocations we have in the world economy. Much of Asia has grown over the last couple of years by subsidizing their exports and by pegging their currency to the dollar, so they have industries that wouldn't be viable if their currency was allowed to appreciate.
It's our assessment that while there's speculative potential in these currencies, when push comes to shove, these governments and central banks will do anything in their power to remain competitive and will engage in possibly irrational moves to devalue their currencies. Then, the de facto winner in this game is Europe, as Europe doesn't interfere in currency markets as much and the European Central Bank has been more conservative than other central banks. We believe Europe is going to continue to be the beneficiary as it has been over the past year.
So how do you invest along that theme?
Switzerland is a conservative way of playing some of the revaluation in Asia. A lot of the reasons why, for example, the yen has been low is the carry trade, where people have been borrowing in low-interest currencies to invest in a higher-interest currency. For example, you can borrow in yen to buy the New Zealand dollar, and pay only 1% in yen and get 7% in the New Zealand dollar. People have also been doing that with the Swiss franc. It has less speculative potential, but it has fewer risks than the Asian currencies.
There's a speculative potential in Asia, but if the main reason for going beyond the dollar is you're concerned about the dollar itself, then Asia isn't the place for you to go. Stick to the more conservative currencies that are more likely to retain their value and benefit from the deterioration in the dollar.
Does your fund hedge?
We don't hedge, and we don't leverage. There have been a number of new products in that market, and they're all a little different, which is nice. By not using leverage, we tend to attract the long-term investor.
In the leveraged products, you'll do great if you know what the dollar is going to do tomorrow. But if you want to be long-term out of the dollar—because you don't know when the dollar is going to go down but think there are pressures on the dollar—then you may want to choose a non-leveraged product. It's not as exciting, but you don't lose your shirt in a flat market. That's the reason we don't have any leverage.
How would your fund fit into a person's portfolio?
One group of investors we have is concerned about asset valuations in the equity markets, bond market, and real estate. So where do you put your money? You traditionally move it to cash. But what if you're also concerned about cash—dollar cash, in particular?
In my view, there's no such thing anymore as a safe asset, and something as simple as cash deserves a diversified approach. For example, you can use gold as an alternative or supplement. We offer a basket of hard currencies as a new way to diversify.
Another way some folks use it is as part of their international-bond allocation. A typical bond fund measures its interest rate risk in terms of years of duration. We have an average maturity of 90 days or less, so we only invest in money-market instruments. This means we try to give investors the currency moves, but we try to mitigate the interest rate risk and avoid equity risk.