Their approaches are not always as simple as you might think.
When the U.S. dollar is falling sharply against most other currencies--as was the case in 2006--or rising just as strongly, we hear from plenty of folks wondering how various mutual funds are positioned. Are the funds fully exposed to currency movements or are they negating that exposure by "hedging" back into the dollar?
The answers aren't as simple as you might think. Sure, many funds that own foreign stocks just don't hedge at all. So, if they put 10% of their portfolio into Swiss stocks, say, they also have 10% of their assets in the Swiss franc. But plenty of funds take other approaches--and those methods get far more complex than simply going to the other extreme and hedging all the exposure back into the dollar all the time.
In an era when even a casual follower of the financial news will often hear alarming stories about the ups and downs of the dollar, euro, and yen--and when these movements are having a substantial impact on mutual fund returns--it pays to understand how funds handle this issue. You may prefer one approach or another. Equally important, knowing these details can help you interpret your fund's performance more accurately--and keep you from being surprised or unduly disappointed.
The Currency Effect
To put it simply, when a U.S.-based fund buys stocks on a foreign stock exchange, the fund pays for it in that country's currency. The stock moves up or down in that currency. But when the fund calculates its return, it must do so in dollars. So, if the foreign currency is worth more in dollar terms than it had been when the fund bought the stock, the fund--and its shareholders--get a bonus. The reverse is true when the foreign currency falls against the dollar.
In 2006, this phenomenon had a tremendous impact on fund performance. In fact, much of the well-publicized outperformance of foreign markets and international funds in 2006 owed to the rise in the euro, pound, and many other currencies. The euro gained about 10% against the dollar and the pound 12%; among the major currencies only the yen, which was roughly flat against the dollar, failed to join the party.
Different Ways to Play
The simplest approaches to take are being fully unhedged and being fully hedged. Most international funds take the first approach, with Fidelity's funds serving as a prominent example. They just buy the stocks and let the currency do what it may. Of course, such portfolio managers do typically take into account currency effects when evaluating stocks; for example, a company that relies heavily on exports to the United States might find its prospects damped when the dollar is weak. But these managers don't actively try to alter the resulting currency exposure.
Very few funds take the opposite approach. Tweedy, Browne Global Value
A third approach is for a manager--or an associated currency team--to make active currency plays in an effort to bolster returns simply through currency trading. Very few stock funds do that. Among the few that do is Oppenheimer Global Opportunities