The ups and downs of the dollar can help or hurt a fund that invests in foreign securities. By Thomas M. Anderson, Contributing Editor December 4, 2006 If you invest in overseas funds, you may have been benefiting lately from the steady decline of the U.S. dollar, which has slipped to its lowest level against the euro in 20 months. But the degree to which you gain from a deteriorating dollar -- indeed, whether you gain at all -- depends on how the managers of the funds you own treat currency and where in the world they invest. Here's an example of how a shrinking greenback can help a U.S.-based investor. One euro was worth $1.18 on New Year's Day 2006. Eleven month later, that same euro is worth $1.33. So if you bought one share of a foreign stock for 10 euros (or $11.80) on January 1, it is now worth $13.33 a share just because of the decline in the dollar's value. The situation reverses if the dollar rises. U.S. investors holding stocks and bonds denominated in euros, yen and pounds -- the major foreign currencies -- will see the value of their investments decline if the dollar strengthens (assuming no change in the value of the underlying security). Managers generally use three methods to deal with the ups and down of exchange rates. Most don't hedge at all, so the effects of currency swings show up in their funds' performance. Others do hedge against currency fluctuations. Typically, stock-fund managers who hedge out currency risk do so because they feel they are first and foremost stockpickers and they don't have any feel for currency fluctuations. A policy of hedging always helps when the dollar is strong but hurts when the buck weakens, which has been the case for most of the past few years. Still other managers selectively hedge to enhance fund performance. But currencies are not monolithic. The dollar can weaken against some currencies and maintain its value or even strengthen against others. For example, if your foreign funds hold many Japanese stocks, they probably haven't gotten a big dollar-related bump this year. "Funds with yen exposure have been hurt, as that currency has weakened relative to the dollar this year," Eric Kobren, editor of the newsletter FundsNet Insight, says in the December issue of that publication. Currency swings make owning foreign stocks and bonds more volatile. The MSCI EAFE index, an unhedged gauge of foreign stocks, is about 38% more volatile than Standard Poor's 500-stock index because of currency movements, says Kobren. He recently reduced foreign fund exposure in some portfolios for investors with a moderate risk tolerance. Among foreign stock funds open to new investors, Artisan International Value is Kobren's favorite. As of October 31, the fund (symbol ARTKX) held 43 stocks, with a relatively modest 14% of assets in Japanese shares. It returned an annualized 27% over the past three years through December 1, according to Morningstar. The fund beat the EAFE index by an average of five percentage points a year. Lead manager David Samra's stockpicking skills and his focus on Europe have been the keys to the fund's superior results, Kobren says. Samra buys cheap foreign stocks he thinks have the potential to return 30%. He only hedges when the fund has a substantial exposure to a particular currency that he believes is significantly overvalued. So, for the most part the fund does benefit from a weakening dollar. If you want to invest in a foreign stock fund that hedges much of its currency exposure, consider Longleaf Partners International (LLINX). Partly because of its currency hedging, the fund, which held just 21 stocks as of September 30, returned a sub-par 14% annualized over the past three years. Relative performance would almost certainly improve if the dollar strengthened. But beyond knowing your funds' currency-hedging policies, you shouldn't get hung up over exchange rates. Unless you have a strong feeling about which way the dollar is heading, you're probably best off investing in well-run international funds and letting their managers decide how to deal with dollar fluctuations. And if you do have a strong feeling about the greenback, you'll probably be better off not acting on it because currency moves have a way of confounding most investors, amateurs and pros alike.