Funds That Profit From a Falling Dollar

Long-term the greenback is headed down. Insulate your wealth against its decline with these funds.

Take it from Wayne Gretzky: In your portfolio, as in hockey, you want to skate to where the puck is going, not to where it's been. So even though the U.S. dollar has moved higher over the past year, you should follow the economic clues that point in the opposite direction: down.

The hefty U.S. current-account deficit, which clocked in at $673 billion in 2008, tells much of the story. That figure represents the difference between what the U.S. pays to other countries for goods, services and income from investments, and what it receives from other countries. As Axel Merk, chief investment officer and president of Merk Investments, explains, the gap implies that foreign investors have to purchase more than $2 billion of dollar-denominated assets every day just to keep the dollar from falling.

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Foreigners gladly snapped up dollar-denominated assets, particularly Treasury bills and bonds, in late 2008 and early 2009, when financial Armageddon loomed. The dollar is, after all, still the world's reserve currency and considered highly safe. That flight to safety fueled a 25% rise in the value of the greenback against a basket of developed-market currencies over the year through March 5.

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But now that Armageddon is off the table, foreign investors have reversed course. In April, foreign governments bought a net $8.3 billion of U.S. Treasury securities, down from $50.5 billion the month before. In total, foreign investors sold a net $53.2 billion of dollar-denominated securities in April.

This trend will continue even if the dollar retains its status as the world's reserve currency. As bond guru Bill Gross, chief investment officer of Pimco, wrote in a recent commentary on his firm's Web site, "Holders of dollars should diversify their own [currency] baskets before central banks and sovereign wealth funds ultimately do the same."

This does not mean you should move your retirement savings into the Chinese renminbi. After all, you probably earn and spend most of your money in dollars. But diversifying your bond or cash holdings with a fund that benefits from a falling dollar could make you some money and provide disaster insurance against the unlikely scenario of a dollar crash.

PowerShares DB U.S. Dollar Index Bearish (symbol UDN (opens in new tab)) is a good choice for a simple, low-cost hedge. The exchange-traded fund is designed to go up when the U.S. Dollar index-which measures the dollar against a basket of six developed-market currencies-goes down. The fund, which achieves its objectives by selling short currency-index futures, charges annual expenses of 0.50%.

But there's something to be said for letting a warm body pick currencies for you. Axel Merk has an excellent record of doing so in Merk Hard Currency (MERKX (opens in new tab)). From the fund's inception in May 2005 through June 17, it gained 5.6% annualized. During the same period, the inverse of the U.S. Dollar index gained 1.2% a year.

Merk crafts the fund with the specific aim of hedging the U.S. dollar. He'll invest in short-term money-market securities to play currencies he likes."We try to avoid interest-rate risk and credit risk," he says. Recently, he also had 14% of the portfolio stashed in gold. Merk likes the Norwegian krone because of the country's healthy economy, and he favors the Canadian and Australian dollars as beneficiaries of rising oil prices. The fund charges 1.30% in annual expenses.

For a bit more oomph, you could invest in T. Rowe Price International Bond (RPIBX (opens in new tab)), which buys longer-maturity issues than Merk's fund does and skips the gold exposure. Manager Ian Kelson invests predominantly in developed-market government debt; that results in a high-quality portfolio, with an average credit rating of double-A.

Like Merk, Kelson is bullish on the Norwegian krone. He's cautious on the euro in the short run, but likes it longer term simply because "it's a realistic alternative to the dollar" for investors and foreign governments looking to diversify their dollar holdings. He thinks the British pound is attractive for its cheapness relative to other currencies, despite severe economic problems in the U.K. Over the past ten years through June 17, the fund gained 5.4% annualized. It charges 0.81% in annual expenses and recently yielded 2.8%.

Loomis Sayles Global Bond (LSGLX (opens in new tab)) offers the most corporate-bond exposure and the highest yield of the bunch. Corporates recently accounted for more than half of the fund's assets, with the rest stashed in debt guaranteed by assorted governments. However, as a global product, the fund invests about 40% of its assets in dollar-denominated securities, so it isn't a pure play on a weak buck.

Co-manager David Rolley says he and co-managers Kenneth Buntrock and Lynda Schweitzer manage the fund relative to the Barclays Capital Global Aggregate Bond Index, which is "designed to show the performance of all investment-grade bonds, all over the world." The index provides managers a fallback "neutral" currency allocation they can use if they're not sure about the direction of a currency, but they're not wedded to the index when they feel strongly about a position. Over the past ten years, this approach has returned 6.2% annualized. The fund sports a current yield of 5.1%.

For now, the team is in wait-and-see mode. Rolley is also bullish on the Norwegian krone and is mildly bullish on the euro. He thinks that the rally in currencies of countries with big energy holdings, such as the Australian dollar and the Brazilian real, has gotten ahead of itself, so he's waiting for a pullback before stashing more money in those areas.

Rolley predicts that the dollar's journey will be bumpy. After all, he says, at some point the Federal Reserve will have to start raising short-term interest rates-a textbook driver of currency appreciation. When that happens "investors are going to freak out and say 'Oh my God, why are we short the dollar?'" That should spark short-term rallies along the road of the dollar's longer-term decline. The Loomis Sayles fund charges 1.00% in annual expenses.

Elizabeth Leary
Contributing Editor, Kiplinger's Personal Finance
Elizabeth Leary (née Ody) first joined Kiplinger in 2006 as a reporter, and has held various positions on staff and as a contributor in the years since. Her writing has also appeared in Barron's, BloombergBusinessweek, The Washington Post and other outlets.