More quantitative easing by the Federal Reserve means more dollars are going to be printed. The Fed has hinted that it plans to purchase another round of long-term treasuries next week in hopes that it will push rates lower, encourage lending, and kickstart the economy. The worry for many U.S. investors is the future of the greenback, as more dollars (actually, bank reserves) in circulation dilutes the currency's value. "Bottom line, we're in this low interest-rate environment, and it looks like there's going to be more quantitative easing, and it doesn't bode well for the dollar," says Tom Lydon, editor of ETFTrends.com. "You want to protect against the sliding dollar."
Quantitative easing has implications for your portfolio. As Chuck Butler, president of EverBank World Markets, which offers savings accounts denominated in non-dollar currencies, points out that you wouldn't put just one stock in a diversified portfolio, so why would you only invest in one currency? The case for investing in currencies is two-fold: It provides a hedge against the threat of inflation in the United States and it further diversifies your portfolio, so that you're not only invested in dollar-denominated assets. Butler says investors should think of foreign currency investing as buying the stock of a country. You'll want to check the country's balance sheet (its debt-to-GDP ratio, for example), political situation, and its currency's yield, as well as its relative attractiveness compared with other currencies.
The dollar remains the undisputed global reserve currency. But just like with other asset classes, experts argue that it's important to be diversified among currencies so that you're protected if the dollar falls in value. "The idea there is simply that diversification can be helpful just for the sake of having exposure to as many different assets as possible," says Morningstar analyst Gregg Wolper. Protecting yourself against currency risk is just like guarding against interest-rate risk or credit risk. Here are three ways investors can get exposure to various types of currencies in their portfolio:
Savings accounts. It's possible to open a savings account or a certificate of deposit and convert your dollars into a single foreign currency or a basket of currencies. Butler says many investors that use his bank's products start with an account that holds a single currency. Later, some decide to buy a basket of foreign currencies that have similar characteristics. For example, EverBank's Commodity Basket CD invests in the currencies of commodity-rich countries. The account's investment is split four ways with holdings in the Australian dollar, the Canadian dollar, the New Zealand dollar, and the South African rand. The idea is simple: If the currencies you hold appreciate, the value you hold in dollars go up. If the currencies depreciate, what you hold in dollars will go down in value. You can also earn interest on the foreign currency that you hold, depending on the interest rates of that given country. The rate will fluctuate with the currency, and you can lose money in these accounts. There is a small upfront currency exchange fee but no monthly fees.
Exchange-traded funds. More than 30 currency ETFs are available to investors, according to Morningstar. Some funds, like Rydex CurrencyShares, allow investors to invest in physical currencies, and track the interest rates of specific currencies. The interest is accrued on a daily basis and reinvested monthly, according to Lydon. Investors can also take the basket approach. Lydon recommends PowerShares DB G10 Currency Harvest (DBV), which tracks currencies of the 10 developed countries that make up the G10. This fund is unique in that it periodically rebalances so that it overweights the highest yielding currencies and underweights the weakest currencies. The fund uses the three-month interest rates of the G10 currencies and goes long on (makes a bet for) the three with the highest rates, and shorts (makes a bet against) the three with the lowest, according to Lydon. It rebalances each quarter. Year-to-date, the fund is down 1 percent. It returned more than 20 percent in 2009.
Local currency funds. Before investing in an international mutual fund, it's important to determine whether it uses currency hedges or if it purchases assets priced in local currencies rather than U.S. dollars. Hedging often involves selling the foreign currency and buying U.S. dollars. Most international stock funds aren't hedged, Wolper says, and are therefore exposed to the ups and downs of the foreign currencies. This may be the simplest way for investors to get a bit of foreign currency exposure. Among fixed-income funds, Alice Lowenstein, director of managed portfolios at Litman/Gregory, favors PIMCO Emerging Local Bond (PELBX) for investors who "want to manage the risk of a gradual but significant decline in the U.S. dollar." Litman/Gregory recommends that clients have a small allocation to this fund because many emerging market countries currently have better fiscal situations, which in turn leads to a better outlook for their currencies. Many of these countries currently have less debt than their developed counterparts like the United States, so the outlook for growth in those countries is much higher. PIMCO's management mostly invests in the local currency of the debt of governments of these emerging markets countries.