Why Some Investors Hold Foreign Currencies

Monday, 21 Oct 2013 01:53 PM

 

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You've heard of Doomsday Preppers: folks who think cataclysmic events are on the way, and who want to be prepared by stockpiling resources.

Now meet the Currency Preppers.

With government dysfunction on full display in Washington, and the Federal Reserve continuing its policy of bond buying known as quantitative easing, some investors are feeling highly unsettled about the future of the U.S. dollar, which hit eight-and-a-half month lows on Friday against the euro and a basket of foreign currencies. So much so, they have decided to hold some cash in foreign currencies.

Investors like Bernie Koerselman. The 78-year-old from Surprise, Arizona, has an Australian dollar deposit account with Jacksonville, Florida-based EverBank, and in the past has owned currencies like the Brazilian real and the Canadian dollar.

"I think it's inevitable the U.S. dollar is going to depreciate significantly in value," Koerselman says. "We're printing money like there's no tomorrow, and we're losing our status as the world's reserve currency. I don't see any way out."

Koerselman isn't alone in keeping a little cash in foreign denominations. According to Chicago-based research firm Morningstar, investors hold roughly $3.3 billion in currency exchange-traded funds, about $2 billion of that in single-currency products, and the rest in baskets of multiple currencies.

Among those with the biggest year-to-date inflows: the CurrencyShares Japanese Yen Trust, and the Market Vectors Indian Rupee/USD exchange-traded note.

The top currency for deposit accounts at EverBank, which offers CDs and deposit accounts in a variety of foreign currencies: the Chinese renminbi, perhaps revealing investor sentiment about where the world is headed. The champ for Certificates of Deposit: the Australian dollar.

Another popular EverBank product is its CD basket of currencies from commodity-rich countries, consisting of the dollars from Australia, Canada and New Zealand, along with the South African rand.

"The majority of our clients have a negative view of the U.S. dollar," says Chris Gaffney, senior vice president of EverBank's world markets division.

"Investors are worried about default, or about debt levels and the amount of money in circulation, or about something else taking over as the world's reserve currency," Gaffney says. "But no matter what your views of the dollar, you should be diversified, and not hold all your investments in one currency."

After all, central banks around the world hold foreign-exchange reserves as a matter of course. After the greenback, the world's central banks are holding euros, British pounds, Japanese yen and Canadian dollars, in that order.

EverBank's Gaffney suggests holding 10 percent to 20 percent of one's portfolio in non-USD-denominated assets. The average sum that EverBank clients allot for foreign-currency CDs and deposit accounts: $40,000.

Another attraction of foreign-currency CDs is their yield, typically much higher than anything that can be found in U.S. bank products at the moment. EverBank is offering 5.75 percent interest on a three-month CD for the Brazilian real, for instance.

It's one thing, though, to set a little money aside in foreign currency if you are truly worried about the future of the U.S. dollar and such a move gives you peace of mind. It's another thing to bet big on currency fluctuations, which can be highly volatile and subject to forces beyond your control.

"It's a tricky business," says Javier Paz, senior analyst for the wealth management practice of the Boston-based advisory firm Aite Group and author of "The Forex Trading Manual." "The themes that lead someone to hold exposure to one currency pair can change after a few weeks or months, because central banks are intervening indirectly in how FX markets are functioning."

You can deal with currency concerns in other, safer ways, suggests Rick Ferri, author of "All About Asset Allocation" and head of the financial advisory firm Portfolio Solutions in Troy, Michigan.

"My preference for holding foreign currency is through international equity index funds, like the Vanguard Total International Stock Index fund," Ferri says. "They are probably the lowest-cost and most efficient way to hedge against a decline in the U.S. dollar, without giving up equity exposure."

Using currency ETFs or other means is costly and less effective for long-term investors, Ferri adds: "The products are designed for currency speculation, which is something that wise investors know to avoid."

In fact, Bernie Koerselman does deploy foreign equities as yet another hedge, in particular Canadian stocks, which he sees as relatively conservative and high-yielding. But he also enjoys having a little foreign cash on hand, in case the U.S. dollar really takes it on the nose.

"Most investors have no comprehension of using other currencies as a hedge, and have never even heard of it," Koerselman says. "But at this point I don't think we can avoid a devalued dollar. It may take some years yet, but I'm patient."

© 2014 Thomson/Reuters. All rights reserved.

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