PersonalFinance and Health Today

New Ways to Wager on the Dollar

June 26, 2005
Sunday Journal

By CRAIG KARMIN Staff Reporter of THE WALL STREET JOURNAL

Mutual funds have never been a particularly good way for small investors to play the foreign-exchange markets. Perhaps that was just as well -- currency movements can be notoriously unpredictable.
But the fund companies' thinking has changed. The dollar's big drop since early 2002 has attracted fresh attention to currency markets at a time when existing alternatives for benefiting from strengthening foreign currencies -- mainly international stock or bond funds -- offer only indirect plays on the dollar.
In the past few months, three mutual fund companies have introduced funds that allow investors to benefit from gains in foreign currencies against the dollar, including the Merk Hard Currency Fund. Two of these fund companies -- Rydex Investments and ProFund Advisors -- also offer products that reward investors when the dollar rallies, as it has been doing for most of this year. The U.S. Dollar Index, which tracks the dollar against a trade-weighted basket of six major currencies, is up nearly 10% this year, while the euro has fallen 11% this year against the greenback.
The new currency funds join Franklin Templeton's Hard Currency Fund, an actively managed fund that was established in 1989 and, until recently, was essentially the only game in town.
"Currency is one of the most traded investments out there," says Michael Sapir, chairman and chief executive of ProFund Advisors. "But it's been low profile for most investors."
Other fund companies may soon enter the currency arena. Goldman Sachs Asset Management is in the early stages of launching the Goldman Sachs Global Currency Fund, according to a filing with the Securities and Exchange Commission. It will also be an actively managed fund and require an minimum initial investment of $1,000.
Managers of these funds maintain that even if currency movements are difficult to predict in the short term, the long-term picture is clearer because major currencies tend to move in multiyear cycles. "History shows the dollar moves in long-term trends relative to its economic fundamentals," says David Reilly, director of portfolio strategy at Rydex.
The dollar, for instance, enjoyed a broad rally from 1995 to 2001, and then saw declines from 2002 to 2004. The dollar's recent rally has split the currency analyst community: some see it as merely an extended pause in a longer-term bear market, while others think the dollar's worst days may be behind it.
For Andrew Clark, a senior research analyst at Lipper, these conflicting views among professional analysts underscore why currency funds are not appropriate as a core holding. "They're too speculative," he says.
That doesn't mean these funds can't be beneficial as a means to diversify a portfolio. Studies show that rises and falls in currency funds have little or no correlation with the movements of major stock and bond indexes. That means currency funds are less likely to move consistently in the same direction as other funds, which means foreign-currency funds should lower an overall portfolio's risk. Currency funds, Mr. Clark adds, charge about the same fees as international stock and bond funds and less than many emerging market funds.
Although some analysts say an international bond fund that does not hedge its currency position can provide similar diversification, Mr. Clark has his doubts. For one thing, most funds don't reveal how much they hedge, so the funds' exposure to foreign currency movements is unclear. Moreover, bond funds respond in large part to interest rates.
"So if interest rates are going up," says Mr. Clark, "the bond fund could fall and undermine any gain from currency movements."
Currency funds held little appeal in the late 1990s when the dollar was strong and the stock market was booming. In 1997, Fidelity Investments shut down its currency funds. Things changed this year as the dollar's three-year slump -- it fell more than 50% against the euro at one point -- was grabbing headlines and encouraged some fund companies to test the waters with currency funds.
Merk Hard Currency Fund is for investors who think the dollar has further to fall in the years ahead. The fund requires a $2,500 minimum to invest directly and currently holds just four currencies: the euro, Swiss franc, Australian dollar and British pound. It also keeps 20% of its assets in gold, which typically moves in the opposite direction of the dollar.
Axel Merk, president of Merk Investments, argues that the record U.S. trade deficit will balloon further, and over time this will reassert pressure on the dollar. His fund will hold only currencies from countries that do not regularly intervene to weaken their currency versus the dollar, which means he excludes the Japanese yen as well as most other Asian currencies.
This puts him at odds with Templeton's fund, where the portfolio managers reason that because the U.S. trade imbalances are largely with Asia, these currencies are poised for the biggest gains versus the dollar. Their recent track record has been solid, with a five-year cumulative total return of 36%. But Templeton was caught off guard by the strength of the dollar's recent rebound, joining many currency speculators who have lost money this year. The fund, which requires a minimum investment of $1,000, is down 4.5% year to date.
ProFund Advisors, by contrast, offers investors the choice of betting whether a basket of currencies will rise or fall versus the dollar. While the funds were launched in February at a time when few analysts were predicting a dollar rebound, the Rising U.S. Dollar Fund has attracted assets of $82 million, compared with only $12 million in the Falling U.S. Dollar Fund. A $15,000 minimum investment is needed to open a ProFund account directly. But that money can be invested in either currency fund or any of the other dozens of mutual funds.
Rydex's Strengthening Dollar Fund and Weakening Dollar Fund both employ the same premise of investing in a basket of currencies but with a twist: the funds offer double the return of the dollar indexes on a daily basis by using derivatives. So if an investor has $1,000 in the fund and the index rises 5% for the day, the investor enjoys a gain of 10%, or in this case $100. This also means double the losses when the indexes fall. Rydex also requires a minimum of $25,000 to open an account with the fund company, though that money can be invested in any of Rydex's nearly 50 mutual funds, not only in the currency funds.
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