Wall Street Pushes to Buy Currencies as Dollar Weakens

Wall Street is increasingly encouraging individual investors to bet on foreign currencies, and money managers are rolling out a host of new funds to allow them to do this.

With many strategists expecting the U.S. dollar to continue to weaken in foreign-exchange markets, a number of Wall Street firms have begun advising individual investors to put a small portion of their assets into euros, yen and other currencies that are likely to increase in value as the dollar declines.  Spurring the strategy in part are concerns that a falling dollar could boost inflation which in turn could hurt prices of bonds and some stocks.  Holding foreign currencies in a portfolio could help investors hedge against problems a falling dollar could create.

But other financial advisers warn that foreign-currency funds are a risky gamble that doesn’t generate long-term investment returns and advices investing in traditional investments such as international stock funds, which can get a boost in dollar terms when the U.S. currency declines.  However, foreign-currency funds are proliferating, with offerings ranging from mutual funds that buy money-market-type investments denominated in foreign currencies, to funds that use complex strategies including trading derivatives and short-selling, or selling borrowed securities in order to profit from an expected decline. Some funds employ leverage, or borrowed money, to magnify their exposure to currency movements.  But this strategy also can exaggerate any losses, and can make funds more volatile.

Rydex Investments recently launched its Euro Currency Trust, which invests in the European currency, and now plans six more exchange-traded products that track the British pound, Australian dollar, Mexican peso and others. Merrill Lynch last month launched the Global Income Currency fund, a new closed-end mutual fund managed by Nuveen Investments that invests in various foreign currencies.  Other launches of currency mutual funds are being planned by Ameriprise Financial Inc.'s RiverSource Investments and Rafferty Holdings LLC's Direxion Funds.  These developments mark a significant shift for individual investors since most financial advisers have rarely steered individual investors into foreign currencies. That has long remained the domain of large, professional investors because foreign exchange often involves complex financial contracts and high transaction costs.

Investors making bets on foreign currencies face a number of risks.  First, currencies are volatile and unpredictable.  There's no guarantee that the dollar will continue to decline in the months ahead. If the U.S. economy experiences strong growth, the Federal Reserve could continue to raise short-term interest rates, which could push the dollar higher.  Second, some advisors say the new currency funds are too expensive. The Rydex Dynamic Weakening Dollar Fund and the Falling U.S. Dollar ProFund, both of which are linked to the performance of the New York Board of Trade's U.S. Dollar Index, each charges annual expenses of over 1.5 percent of assets. The average index fund charges expenses of 0.71 percent. 

But a number of strategists see a place for foreign currencies in client portfolios. Morgan Stanley's Global Wealth Management Group, which serves individual investors, recently began for the first time advising clients to invest about 3 percent of their assets in the Rydex Euro Currency Trust, which holds euros in an interest-bearing account. Overall, the firm recommends that clients with moderate risk tolerance keep about 16 percent of their assets in international stocks and nothing in overseas bonds.

Lehman's Private Investment Management group last month recommended clients move money out of international bonds and invest instead in foreign currencies, the first time it has recommended such an investment.  For clients with average risk tolerance, the firm suggests investing 8 percent of total portfolio assets in money-market-type investments denominated in foreign currencies. Some of the new currency funds, like Merk Hard Currency, emphasize such investments. Lehman recommends investors with moderate risk tolerance devote 19 percent of their portfolio to international stocks. However, the firm says to steer clear of international bonds because it expects interest rates overseas to rise. "We're looking for the least risky way of providing protection and maybe making a little money, and that would be non-dollar cash," says Aaron Gurwitz, senior strategist at Lehman Brothers.

After gaining ground against the euro and the yen last year, the dollar is down 6.2 percent against the European currency and 4 percent against the yen so far this year. Strategists expect this trend will continue, especially amid expectations that the Fed will soon end its campaign of boosting short-term interest rates.  At the same time, interest rates are expected to head higher in overseas markets. This makes investments in those countries more attractive, which boosts the value of those countries' currencies against the dollar.

Individual investors have long been able to bet on foreign currencies using complex financial contracts, including currency futures. Such investments carry significant risks, however, because they require investors to speculate on the direction of particular currencies and often involve borrowed money. The new currency mutual funds and exchange-traded funds, which resemble traditional mutual funds but trade like stocks on an exchange, are less risky, financial planners say, because many of them offer a diversified basket of foreign currencies and the expertise of a professional money manager.