Dealing with the Dollar

If you’ve been flirting with the idea of finally taking that coveted European vacation, you might want to wait. The depressed state of the U.S. dollar has turned the cost of your foreign excursions from a small fortune into a major one.

Despite tough talk from Treasury Secretary Timothy Geithner and other federal officials about a strong dollar being in the best interest of America, the dollar continues to sag further and further into the mire. Is oblivion the next stop?

The dollar’s drop isn’t worrying just Americans, but the world abroad. Thailand, South Korea, Russia and the Philippines were recently net buyers of the dollar. This was seen as a move to hold down the value of their respective currencies. If those currencies become too strong relative to the dollar, it hurts the ability of these countries to compete for business as their exports become too costly.

China’s currency, the yuan, is linked to the dollar. As the yuan falls in value with the dollar, China creates a competitive advantage for itself by keeping its export prices lower. While China may flourish, other regions like Europe are growing considerably uncomfortable with a depressed dollar. A strong euro comes at the cost of unaffordable exports for American consumers. The end result is lackluster business.

Currency Choices

From an investment perspective, how can you help your clients to successfully combat a weakened dollar? Let’s evaluate some strategies for dollar hedging.

Besides providing securities diversification, almost all index funds and index ETFs provide currency diversification too. Unlike actively managed funds, which sometimes hedge with currencies, index funds provide unhedged currency exposure. Simply put, the foreign securities inside index funds are priced in local currency.

Foreign-stock ETFs that are a good foundation for non-US equity exposure and currency diversification include the SPDR MSCI ACWI ex-US ETF (CWI) and the Vanguard All World FTSE Ex-US ETF (VEU). Single-country ETFs like the iShares FTSE/Xinhua China 25 (FXI) and the Market Vectors Russia ETF (RSX) also provide the foreign exposure, but with higher volatility.

“Many investors invest their equity-earmarked money solely in U.S. stocks, thinking non-U.S. investments are inherently more risky,” says Joseph Childrey, managing partner with Childrey Investment Partners in La Jolla, Calif. “In recent years, the correlation between U.S. and non-U.S. markets has increased and the standard deviation [risk] is about the same. Therefore we feel investors who ignore the foreign markets are missing out on investment opportunities.”

Don’t overlook foreign bonds too. Tom Anderson, head of strategy and research at State Street Global Advisors, emphasizes that foreign inflation-protected securities (WIP) are useful for U.S. investors seeking inflation protection minus dollar exposure. State Street also manages an international Treasury bond fund (BWX), which was up 8.51 percent through October.

The falling dollar has attracted a lot of excitement among commodity investors, particularly the gold enthusiasts known as goldbugs. Since commodities are priced in dollars, their value rises when the dollar declines. This partly explains the resurgence in gold prices (GLD), which hover around $1,100 per ounce. Since the beginning of 2009, GLD has gained around 25 percent.

For broader market exposure to a basket of commodities, one possibility is the Greenhaven Continuous Commodity Index Fund (GCC), which offers equal weight positions to 17 different commodities. Each commodity is assigned a 5.88 percent index weighting and rebalanced daily.