Fighting the Sliding Dollar

We've had quite a rally, but among key concerns that currently threaten to blight the fun is the dollar. The greenback has declined steadily since the beginning of the rally in March, and there is widespread agreement that we've not seen the bottom yet. What's not clear-cut, however, is how investors might fight this trend.

Foreign currency funds, precious metals, commodities, and similar alternative asset classes are being mooted as possible ways to shield portfolios from a dollar rout. Those ideas can diversify a portfolio. Yet, a good old foreign bond fund would be up to the task, too, and arguably a more sensible fix for most investors. An unhedged foreign bond fund will buy you exposure to foreign currencies and also offer far more potential for price appreciation than currency funds (which hold essentially cashlike instruments). Precious metals will hold up when paper currencies tumble, but they (most notably, gold) are at record highs these days, and their valuations are questionable. And although commodities' could also be better stores of value than paper money in the long run, their prices remain vulnerable to business cycles. In comparison, foreign bond funds look like a decent option that investors can incorporate into their portfolios without much head-scratching.

Before discussing a few eligible candidates, some caveats are in order. Currency movements are notoriously unpredictable and will defy the most rational consensus view. Moreover, many investors may already have a measure of nondollar exposure through foreign stock funds or even domestic blue-chip funds that feature many companies that earn sizable chunks of their revenue abroad. Thus, don't overestimate your need for foreign currency allocation. The following fund examples also are among the world-bond category's bolder options that deploy a wide range of securities and active currency bets, so make sure you are comfortable with their risks. Also, the securities in these funds can suffer capital losses (which will erode any currency gains), though in the long run you should come out ahead of a cashlike currency fund.

 Loomis Sayles Global Bond (LSGLX)
This global bond Analyst Pick had a tough time last year due to the portfolio's heavy corporate stake, but that very emphasis is powering the fund to a topnotch finish in 2009. The fund's veteran managers clearly rely heavily on their firm's global expertise in bottom-up credit research, but they have shown the ability to make well-calculated shifts into other sectors as well. For example, management took profits in many of the portfolio's biggest corporate winners this year and bought higher-rated government bonds in Norway and Canada (those countries' currencies have staged some of the biggest moves against the U.S. dollar this year). Strong issue selection should continue to give this fund a significant edge over more passive vehicles for nondollar exposure.

 Templeton Global Bond (TPINX)
Unlike the Analyst Pick discussed above, this one sticks to government bonds, but there are plenty of bold statements in the portfolio. For example, the fund currently has a 21% stake in South Korea bonds alone and a combined 14% stake in Brazil and Mexico. Veteran manager Michael Hasenstab argues that those developing countries' bonds and currencies are backed by a great combination of fiscal responsibility and cheap valuations. This logic underscores a key point in the whole currency debate. Many developed markets (including Japan, United Kingdom, and several in the eurozone) face the same pressures as the U.S. The central banks of these developed countries all have limited ability to support their currencies because of the continued need to bail out or support private debt markets. Thus, Hasenstab's approach to diversify the fund's currency exposure beyond the "usual suspect" choices makes sense. Also, he has a great long-term record through many different market environments owing to his patient, valuation-conscious approach.

 Oppenheimer International Bond (OIBAX)
This is another example of a veteran manager using a flexible approach to great effect. Skipper Art Steinmetz, who was tapped earlier this year to head up the firm's entire fixed-income effort, has considerable leeway here to go into emerging markets and corporate bonds and to make active currency bets. The portfolio currently has a 13% combined stake in Brazil and Mexico, for example, which includes several prominent corporate issues. Again, for investors looking to add currency diversification, the key strength to note here is the fund's ability to deliver plenty of price-appreciation upside on top of the currency gains.

 AllianceBernstein Global Bond (ANAGX)
The strategy here is just as distinct as those at the funds already mentioned, although not as well-tested. Management uses a multisector approach that pulls in the entire spectrum of choices in global bond markets including emerging markets, corporate and asset-backed bonds, and currency plays. To boot, management will use leverage as well. This approach took shape in 2007, after a series of incremental strategy changes that gradually gave management greater flexibility. Granted, the record is not long under the mandate, but we like what we've seen so far. Management will often be early with its bold valuation calls, but patient shareholders have reaped rewards.

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