Terry Tian: Hi, my name is Terry Tian. I'm an alternative investment analyst with Morningstar. Joining me today is Axel Merk, portfolio manager and president of Merk Investments.
Axel, thank you very much for joining me today.
Axel Merk: Great to be with you.
Tian: There are two major types of currency mutual funds: directional and nondirectional. For example your Merk Hard Currency mutual fund and your Asian Currency fund are both betting against the U.S. dollar, which make them directional, and your Absolute Return Currency fund is a nondirectional strategy. Could you explain the differences between those two types of currency funds?
Merk: Certainly. On the directional side as you point out, it's generally that you buy a currency, a basket of currencies, or in the case of a mutual fund, a managed basket of currencies. On the nondirectional side, you are truly trying to take advantage of the differential moves of any currency for or against the U.S. dollar. Think about buying the Australian dollar and selling the New Zealand dollar. You can't guarantee you'll make money with that position, but almost certainly the returns you generate with that will have a very low correlation to anything else that you are doing. So, with that on the nondirectional side, the primary goal tends to be to generate absolute noncorrelated returns, whereas on the directional side, you can have a play against the U.S. dollar. You can also think about it as international fixed-income investing light, where you're taking on currency risk but trying to mitigate interest and credit risk.
Tian: Axel, you have warned investors of U.S. dollar risk. Could you elaborate on that and why do you think that's a good reason for investors to invest in the U.S. Dollar Bear fund?
Merk: Sure. The good news is that I don't think we have a European crisis. The bad news is I think we have a global crisis. It just happens to be focused on Europe right now. And if there is one thing the policymakers listen to, it is the language of the bond market. Well, in Europe, policymakers are moving because the bond market is telling them to. But the euro, while it's been under pressure, it is not falling completely apart, at least not yet, and the reason is there is no current account deficit in Europe, at least not a significant one. In the U.S. we have a current account deficit, so if and when policymakers in the U.S. get the "incentive" of the bond market to do something about the deficits that we have, the U.S. dollar might be under far more severe pressure.
Now on top of that of course U.S. investors are utterly overexposed to the U.S. dollar. S&P 500 companies hedge about 90% of their earnings back into the U.S. dollar. If you invest in international equities, most of these are large multinationals that are again trying to sell to U.S. consumers. Then importantly, if you use currencies, you don't take on the equity risk. People think currencies are so volatile, but currencies, if you don't use leverage, are actually rather boring. So why take on all this equity risk, when everything is so highly correlated, whereas in the currency space you can try to mitigate some of those risks and you can do that in a very pure fashion by buying a currency, by trying to mitigate the risk of any one currency.
China by the way does the same thing. It diversifies the reserves beyond the U.S. dollar because it knows that any one of these currencies is too risky to hold.
Tian: For the U.S. investors, assets are denominated in U.S. dollars. If they don't invest internationally, how are they getting this currency risk?