Or a Yuan. (With apologies to all you Cabaret fans.) Mutual fund investors need to be aware of the currency risks you’re taking (or not taking) when investing internationally. Is your mutual fund hedged against the dollar or not? Do you want your fund to be hedged or not? What difference does it make to you? Let’s start with the last question first.

 

Currencies do fluctuate is value (except for the Yuan, whose exchange rate is fixed by the Chinese government, but it will be revalued upward against the dollar at some point). For example, in 1999 €1.00 cost $.85. Today the exchange rate is about €1.00 = $1.36. (Condolences to any of you who are vacationing in Europe this summer.) Any dollar dominated investor, such as those of us in the good old USA, would have seen substantial appreciate in the Euro dominated investments (European stocks and bonds) we made a few years ago just based on currency movement. The European investor who bought dollar dominated US stocks or bonds wouldn’t have been so lucky. The Dow at 13,000 would have brought little joy to the Euro investor’s heart since most of his or her gains would have been lost to the deprecation of the dollar versus the Euro. 

 

There is a way to protect yourself against currency swings and that’s to buy a mutual fund which hedges – tries to eliminate or minimize the currency risk. No hedge is prefect and all hedges cost money, which reduces your return. But a currency hedge factors out one risk leaving you, the investor, with the underlying risk of the investment, i.e., the return on the bonds or the performance of the stocks in the mutual fund portfolio. Mutual funds disclose whether their fully, partially or not hedged, so read up on your international fund before you invest in it.

 

Hedged or unhedged, which is right for you? It depends, first and foremost, on how much risk you want to take. Remember, an adverse currency swing could wipe out all the fund’s portfolio gains and, particularly in a bond fund actually result in a loss. Secondly, it depends on your outlook for currency movements.

 

Global diversification is a good (necessary?) investment strategy. (For more on this on see my posting: The CIA Guide to International Investing.) Like every other investment, you need to do your homework and know what (and how much) risk you’re taking.