How Should Investors Play the Dollar?Ben Levisohn
The defining event for the world's currencies through most of 2009 was the steady and steep decline of the dollar. In 2010 the dollar will be center stage again—only this time it will be a highly volatile greenback that challenges investors.
In 2009 Asia and Latin America had more dynamic economies than the U.S., so buying securities abroad was a no-brainer: Americans invested $46 billion in overseas markets. That shift put downward pressure on the dollar. So did massive trade and budget deficits in the U.S., a low interest rate policy by the Federal Reserve, and the slow erosion of the dollar's role as the world's reserve currency. The greenback slid almost 17% between early March and late November against a basket of major currencies—the biggest decline for the dollar in any eight-month period since 1986. Investors who shunned dollars also enjoyed a currency boost that added to their return. The Brazilian Bovespa index, for example, rose 85% for the year when measured in the local currency. But the Brazilian real has grown so powerful that the Bovespa's 2009 performance, when translated into dollars, is an even higher 148%.
At the end of 2009, though, the markets got a sharp reminder of how volatile currencies can be. In just a few days the Dubai World bond fiasco and the Greek sovereign debt downgrade drove investors to seek refuge in the recently scorned dollar. U.S. treasuries were snapped up, the euro slumped, and the dollar rose 2.5%.
Investors now anticipate more such blowups and subsequent dollar rallies. That scenario doesn't change the prognosis of overall weakness for the dollar. But with the fragile finances of Britain, Japan, Russia, Spain, Ukraine, and other nations increasing the chances of a scary market event, the dollar's straight-line decline is no longer a given.
So how should investors handle the new volatility? Those who can stomach wild swings can still bet heavily on the dollar's decline. The well-regarded Tweedy Browne Global Value Fund (TBGVX) and Longleaf Partners International (LLINX) now offer unhedged portfolios that invest heavily in non-dollar-denominated securities. Without any hedging against currency shifts, these funds can offer high returns if the dollar plunges—and get hammered if the greenback rebounds.
EMBRACING VOLATILITYOther investors may want to take more preventive measures. Madalynn Matlock, portfolio manager of the Huntington International Equity Fund (HIETX), avoids currencies she believes are heading for a fall, regardless of how much she likes a particular stock. Right now she's bypassing Brazil because of its recent steps to limit the strength of the real, including a 2% tax on foreign investments. Matlock also sees a rising dollar, at least in the near term. Since "everyone is betting against it," she says, a rebound is inevitable.
Some fund managers embrace volatility. The $23.3 billion Templeton Global Bond Fund (TPINX), which is ranked in the top 5% in its category for three-, five-, and ten-year returns according to Morningstar (MORN), actively trades the currencies in its portfolio. That has helped it advance 18.3% in 2009.
The Merk Hard Currency Fund (MERKX) trades in currencies, not stocks or bonds. It has outperformed 99% of currency funds over the past three years, with an annual total return of 7.3%. It has a large stake in the krone of Norway, a commodity-rich nation that "has all the advantages of being in Western Europe and none of the disadvantages," says fund manager Axel Merk.
Some exchange-traded funds mimic actively traded currency funds. One ETF, the PowerShares DB G10 Currency Harvest Fund (DBV), captures the momentum of currencies by buying those of countries with high interest rates. Generally these currencies go up. The fund also sells currencies of nations with low interest rates, since these currencies should fall. It has loaded up on Aussie dollars and Norwegian krone, while shorting the dollar and Swiss franc. The momentum strategy worked well in 2009, but not in 2008. The expected volatility in 2010 will make currency plays that much harder to execute.