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How to Profit From a Strong and Rising Dollar

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Over the past year the dollar has strengthened from about 0.75 euro per dollar to about 0.95. From a broader perspective, the Wall Street Journal Dollar Index, which measures the dollar against a basket of 16 widely traded currencies, rose from 73.9 to 88 by August 20, a 19% increase.

This strength in the dollar is expected to continue due to several factors. The Federal Reserve is likely to raise interest rates in the near future and, as the U.S. economy continues to grow, albeit slowly, increased loan demand could provide another impetus for higher domestic rates.

The impact isn’t all positive. A stronger dollar has had a negative impact on the earnings of U.S. multinationals such as Goodyear (GT) and Procter & Gamble (PG). When they translate foreign sales into the U.S. currency, the value of those sales decline. Still, investors can profit from the rising-dollar scenario, using several alternative investments.

One strategy is to make directional investments based on currency moves; another is to buy stocks in companies with little or no foreign currency exposure.

Chasing the Buck

The first question investors need to answer is whether they believe the dollar will strengthen against every currency in the world or against one or more specific currencies, says Simeon Hyman, head of investment strategy at ProShares in New York City. He cites the ProShares Short Euro Fund (EUFX) as an example of a single-currency directional investment for investors who expect the euro will decline against the dollar.

Investors typically buy EUFX based on one or two assumptions, Hyman says. The first assumption is that the Fed will tighten monetary policy before Europe raises its rates. He describes that as a more or less bullish view on the U.S. economy and a view that the Fed will act. The other assumption is that Europe’s financial drama continues and the turmoil contributes to economic weakness. Should that happen, notes Hyman, it would be another reason to expect further dollar appreciation against the euro.

Investors who believe the dollar will strengthen against multiple currencies should consider the ProFunds Rising U.S. Dollar Fund (RDPIX), Hyman suggests. The fund is based on a market basket index that tracks the dollar against other major currencies. The index allocation is roughly 60% euro, 15% Japanese yen, 12% British pound, slightly less than 10% Canadian dollar and the balance in Swedish Krona and Swiss Franc. In contrast to a euro-only bet, investing in a basket of currencies provides additional diversification, he notes.

Homegrown Profits

New York City-based WisdomTree Funds takes a different approach with its Strong Dollar U.S. Equity Fund (USSD), which is an ETF. The logic behind its construction is straightforward, according to Chris Gannatti, the company’s associate director of research. The firm’s researchers ran a geographic screen to identify companies that earn at least 80% of their revenue within the United States; about 270 companies made the initial cut. WisdomTree then applied a weighting scheme based on each company’s sensitivity to the dollar’s strength.

“In essence, if companies have a higher correlation to the U.S. dollar, weight gets tilted toward them. If companies have a lower correlation with the U.S. dollar, weight gets tilted away from them,” he explains.

The fund’s strategy should appeal to investors who want to avoid currency-based positions while still investing directly in U.S. equities, says Gannatti. He believes that adding the fund to an existing portfolio allows investors to adjust their portfolio’s dollar exposure.

“We envision this USSD strategy can be sliced … to essentially overweight or tilt the portfolio toward those U.S. domestics, those companies that are the opposite of U.S. exporters that could be shielded or at least more shielded from a strengthening U.S. dollar.”

Performance

The WisdomTree USSD fund launched July 21, 2015 so it’s too early to judge its performance, although the underlying investment theme makes sense. The ProShares Short Euro fund has been operating since June 26, 2012. According to Morningstar, the fund has generated a 6.6% year-to date return through August 20, 2015; 16.8% for one year.

Not surprisingly, short-term returns are volatile. Morningstar reports that EUFX’s monthly returns in 2015 have ranged from 7.12% to -4.5%. ProShares Rising U.S. Dollar Fund, launched in February 2005, has gained 4.53% year-to-date return through Aug. 20, 2015 and 13.8% for the year. Monthly returns in 2015 were less volatile than those for EUFX, with a high of 4.71% and a low of -3.82%.

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