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By Jason Stipp | 11-11-2010 02:02 PM

Does a Currency Bet Make 'Cents'?

Morningstar's Michael Rawson on the strategic and tactical rationale for currency exposure, the outlook for the dollar, and the ins and outs of currency ETFs.

Jason Stipp: I'm Jason Stipp for Morningstar. With the Fed's recent policy measures still clear the rearview mirror, currency issues have seemed to take center stage in lot of headlines.

Meanwhile, ETFs have offered investors a lot of different ways to invest directly in currencies, but just because they can, does it mean that they should?

Here with me to talk about how to think about currencies in a portfolio is Morningstar's Michael Rawson. He is on our ETF team.

Thanks, so much for joining me Mike.

Michael Rawson: Thanks for having me, Jason.

Stipp: Sure. So the first question for you: ETFs have democratized the currency space; they've made it easier for investors to access currencies. How have you seen that play out and broadly, what kinds of products are available for ETF investors in this space?

Rawson: Well, certainly I think a lot of people are familiar with investing personally in stocks. They know how to buy stocks and sell stocks in their own account or a through a broker. However, not as many people are familiar with using futures accounts and people are little bit intimated by that.

What the ETF has allowed is for people to trade currencies without having to go open up a futures account. They can directly trade them just like they would a stock like IBM or Microsoft. They can access currencies through ETFs.

However, there is a number of different ETFs out there, and they themselves have different structures. So, investors should be a little bit aware of the different structures of those currency ETFs before they start investing.

Stipp: We'll talk little bit more about some of those in a bit, but first wanted to ask you, as investors are thinking about currencies and as it seems to be that the dollar going up and down has an effect on the market, what are ways that an investor might employ a currency position?

I think, generally, we think of a strategic portfolio and a tactical portfolio. So, for a strategic or a long-term investment portfolio, should investors think about employing a currency bet explicitly or what should their thought process be about that?

Rawson: Well, that's really a kind of a personal decision about how many assets they want to invest in. If they want to keep their portfolio simple, stocks and bonds, and limited it to that, they don't necessarily need to invest in currencies.

However, for someone who really wants to get as much diversification as possible, there is a little bit of room for a small strategic position in currencies, and currencies are a cash instruments much like short-term bond or a money market instrument. So, it should really be thought of as a small portion to replace an existing holding in a money market fund or a short-term bond fund, but again you want to limit it to a small portion of your portfolio because over the long-term currencies like any other cash instrument is going to have a very low rate of return, it probably won't even keep up with inflation. But it does have some diversification benefits in that, it has very low volatility and will benefit if the market were to crater, you'll have access to cash, which is always a good thing.

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