Obtaining a second passport and an offshore bank account are crucial parts of an overall diversification strategy, but they are not the only ones. Capturing international opportunities for your investment portfolio also has an important role and one of the easiest ways to do this is to own foreign currencies. Below are my 10 favorite reasons for doing so.
The above are edited excerpts from an article* by Axel Merk (merkfunds.com) entitled Why I Invest in Currencies.
The following article is presented by Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!) and the FREE Market Intelligence Report newsletter (sample here) and has been edited, abridged and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.
Merk goes on to say in further edited excerpts:
Ignoring the currency market might be perilous to your wealth. Below are my 10 favorite reasons why I invest in currencies:
1. Crash Proof Portfolio
When complacency, on display in ever-lower volatility (just look at the VIX index), is married to a seemingly relentless rise in prices, I get concerned that the stock market may be in bubble territory. As I generally put my money where my mouth is, I currently have my personal equity exposure hedged. I believe the currency asset class can present valuable profit opportunities and diversification benefits, especially as I am ready to take some chips off the table should the stock market come tumbling down.
2. Mania of Policymakers
Currencies are a pure play on macro views and an opportunity to take advantage of the “mania of policy makers,” particularly in today’s era of currency wars.
3. Protect Purchasing Power
Unsustainable fiscal debt and deficits, along with chronic current account deficits funded by foreign debt, can put downward pressure on the US dollar. In my assessment, the Fed will err on the side of inflation rather than face potential deflation following the credit bust. Over the long haul, the dollar has weakened both in absolute terms (purchasing power) as well as in relative terms (foreign exchange rates). U.S. investors can protect their purchasing power by investing part of their assets outside the dollar. A managed basket of currencies is a prudent way to do this.
4. International Exposure with Less Lost in Translation
As is often mentioned in financial research, much of the gains (or losses) on international investments are tied to the fluctuation in exchange rates, rather than the change in the asset value itself. Therefore, why not invest directly in the foreign currency, and manage the currency risk actively, rather than passively being subject to it?
Those who think they get their international exposure through international stock funds, think again: you may have gained more beta (volatility) but not alpha (added value). Some international bonds have offered a seemingly free lunch that appears to have ended, as chasing yield in emerging markets is fraught with risks—a single untelegraphed sneeze from…[Yellen] can send foreign bonds to the emergency room. I get the international exposure I seek by investing in currencies.
5. Large and Liquid Market
Cash is king and liquidity is the kingmaker. The global currency market is the most liquid in the world, with over US$5 trillion in daily turnover, compared to under US$1 trillion for the US bond market and New York Stock Exchange combined.
6. Uncorrelated Returns, Here We Come
The currency asset class has historically shown very low correlations to many other asset classes. In addition, currencies have low correlation with each other. Adding an uncorrelated component, like a currency basket, to an investment portfolio can improve the overall portfolio’s risk/return ratio.
7. Downside Resilience, Anyone?
A common misconception is that currencies are more volatile than stocks, when in fact currencies have historically been significantly less volatile than stocks. Just think about it: a one cent flutter in the euro against the US dollar makes the headlines but is a small move on a percentage basis. The low volatility and low correlation of currencies can help buffer the portfolio when other asset classes tumble. We call this the downside resilience of currencies.
8. Broader Profit Opportunities
Actors such as corporate hedgers, central bankers, and tourists don’t necessarily try to maximize their profits when they buy or sell currencies. The result is that a unique set of market inefficiencies can arise through which the investor can seek to profit.
9. Value of Active Management
In a world of always-engaged policymakers, asset prices seem to no longer reflect fundamentals but instead react to the next perceived move of government policymakers. I believe the currency market is a great way to express one’s view about the actions and interventions of policy makers.
We may not like our policy makers, but we can allocate our money in a way that potentially mitigates some of the risk and captures the profit opportunity from what may lie ahead.
10. Improve Portfolio Risk/Return Tradeoff
As I piece together the above characteristics, it seems obvious that adding an actively managed currency component to an investment portfolio will enhance its overall risk/return profile.
Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.
*http://www.internationalman.com//articles/why-i-invest-in-currencies – Copyright © 2014 Casey Research, LLC. (This article originally appeared in World Money Analyst, a Mauldin Economics publication)
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