With the U.S. dollar in free fall, investors are scrambling to adjust their portfolios, but relatively new, potentially dangerous investment options can make a hedge against the dollar's decline a risky proposition.
It's not that investors shouldn't revaluate their portfolios, said Jack Ablin, chief investment officer of Harris Private Bank, a unit of Harris Bankcorp Inc. of Chicago. A declining dollar can lead to inflation that can eat away at an investor's purchasing power, he said.
That said, it's a mistake to try to game the dollar by directly investing in currencies, Mr. Ablin said.
“The currency space is a treacherous space,” he said.
But not everyone subscribes to that philosophy, as evidenced by the fact that eight exchange traded trusts called CurrencyShares are growing in popularity.
The products, offered by Rydex Investments of Rockville, Md., provide exposure to foreign currencies and are similar in almost every respect to exchange traded funds.
The first such product, the CurrencyShares Euro Trust [FXE], which was launched at the end of 2005, had $955.82 million in assets as of Sept. 28, making it the largest CurrencyShares trust by assets.
Since the end of June, however, the fastest-growing CurrencyShares have been the CurrencyShares Australian Dollar Trust [FXA], whose assets had soared 108% to $171.3 million as of Sept. 28, and the CurrencyShares Japanese Yen Trust [FXY], whose assets had jumped 77% to $866 million, said Edward Lopez, director of ETF strategies at Rydex.
Making a bet on a single currency as a way to game the dollar's decline can indeed be dangerous, Mr. Lopez admitted, but some people overestimate the dangers of using CurrencyShares to make such bets, because they assume they provide leveraged exposure to the market.
Mr. Lopez said that CurrencyShares should be viewed as another tool that can be used both by tactical allocators looking to time the market and by buy-and-hold investors looking for a cash diversifier.
Of course, there are other ways investors can play the currency markets.
It may be tempting to jump into a mutual fund such as the $99 million ProFunds Falling U.S. Dollar Fund — offered by ProFund Advisors LLC of Bethesda, Md. — which is designed to profit from the dollar's decline.
Rydex also has such a fund: the $116.66 million Rydex Weakening Dollar 2X Strategy.
But using such funds to hedge, or even take ad-vantage of, the dollar's decline may be risky, said J. Michael Martin of Columbia, Md.-based Financial Advantage Inc.
Mr. Martin is ad-dressing the currency situation another way: He's putting a portion of his clients' assets into gold ETFs, he said, because gold generally appreciates when the dollar declines, making it a good way to hedge against inflation.
Other advisers aren't so sure gold is the way to go.
Buying gold means understanding when to sell it, and that is something Patrick Hanratty, a managing director with Capital Advisors Ltd. of Shaker Heights, Ohio, is more comfortable with leaving to professional fund managers.
“That's their job, to look at opportunities,” he said. “It's hard for us to do that.”
That doesn't mean advisers can't overweight their portfolio toward managers they think will have the best opportunity to hedge — or even profit from — the dollar's decline.
For example, it is widely understood that a declining dollar results in the appreciation of foreign securities.
That is one of the benefits of owning foreign securities, according to Stephen Gorman, president of Gorman Financial Management in Hingham, Mass., who said advisers may want to consider in-creasing their exposure to mutual funds that invest abroad.
Such a move makes sense, said James Paul-sen, Minneapolis-based chief investment strategist with Wells Capital Management Inc. of San Francisco.
But there is no reason to stop there, he said.
Within the domestic stock market, one area that could improve as a result of a devalued dollar is manufacturing, Mr. Paulsen said. As the dollar weakens, U.S. goods will begin to look more attractive to both foreign and domestic buyers, he said.
Mr. Paulsen also holds the controversial opinion that small-cap stocks could outperform.
Whereas conventional wisdom holds that large-cap multinational companies that do a lot of foreign business will be the ones to benefit from a declining dollar, he said, small-cap companies will get the full benefit because they will be the primary beneficiary of money increasingly spent at home.
While there is a range of opinion on stocks, when it comes to bonds, industry experts are much more united in their opinion about the effect of the declining dollar.
“A weak dollar is ultimately bad for bonds,” Mr. Paulsen said.
One of the few places bond buyers can turn that may hold up is inflation-protected Treasury securities, he said.
Mr. Ablin agrees, adding that it is also a good idea to shift assets into high-quality foreign bonds.
Of course, such moves make sense only if investors think that the dollar will continue to slide.
After all, how much lower can it go?
Last month, Canada's dollar traded above the U.S. dollar for the first time in 31 years.
And last week, the U.S. dollar continued to set record lows against the euro — at one point depreciating to $1.42 per euro for the first time since that currency debuted in 1999.
At least one economist said the trend is likely to continue.
“I wouldn't be surprised to see another 10% decline,” said Joel Naroff, president of Naroff Economic Advisors in Holland, Pa.
David Hoffman can be reached at dhoffman@crain.com.
