What a Weak Dollar Means for Your Portfolio

Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. The U.S. dollar has shown some weakness against foreign currencies during the past few months, after rallying quite strongly for the past decade. So what does the dollar's weakness mean for investors? Here today to discuss the topic is Christine Benz. Christine is Morningstar's director of personal finance.

Christine Benz: Susan, thank you so much for having me.

Dziubinski: Why do you think that we're seeing some weakness in the dollar today?

Benz: Well, it's a little bit of a headscratcher, and there are a lot of conjectures flying around. The reason it's a headscratcher is that, typically, in tumultuous times like what we're living through, we often see the dollar appreciate relative to other major foreign currencies. We've been seeing a little bit of the opposite pattern over the past few months. And one of the prevailing theories is that it may have something to do with some of the spending that has gone on, the deficit spending, and potential effects for inflation in the years ahead, that there are concerns that that could reduce the purchasing power of dollar-denominated assets. So that's one theory.

Another theory is simply that the U.S. has been a little bit behind some other developed economies when it comes to getting this pandemic under control. That could be putting some pressure on the dollar as well.

Dziubinski: Let's talk a little bit about the implications of a falling dollar on investors. There is an impact on U.S. businesses, correct?

Benz: There is. U.S. multinationals, in particular, those that sell a lot of their wares overseas, will tend to benefit when the dollar declines because foreign currencies are stronger. That means that foreign buyers are stronger and more inclined to buy U.S. products. So it's a positive for some of the big companies, whether Coke or McDonald's, companies that do sell their products overseas.

On the flip side, it would be a negative for foreign companies that sell a lot of stuff in the U.S. because our dollars don't go as far toward purchasing some foreign goods. So it's a mixed bag.

One thing to keep in mind, though, Susan, for people who own some of these big multinationals, many of them do employ hedging strategies, foreign-currency-hedging strategies, in an effort to reduce currency-related impacts on their bottom lines. That's sort of a mitigating force here as well.

Dziubinski: Christine, what about investors who own securities that are in foreign-denominated securities? What does a falling dollar mean for them?

Benz: Well, it means that you usually benefit. And so a way to think about it is if you are a foreign stock or bond investor and your security is denominated in that foreign currency, any return or loss that you earn can be decomposed into two parts. On one part is the return or loss that the security itself experiences, and then the other part of your return would be any gain or loss in the value of the currency in which that security is denominated.

To use a simple example: Let's say I own a Swiss pharmaceutical maker, and my stock is denominated in Swiss francs. Well, if the Swiss franc appreciates over my holding period, and the stock appreciates over my holding period, I win on both ends. On the other hand, if the Swiss franc declines over my holding period, but the stock appreciates, that could offset some of the appreciation in the stock.

The good news for foreign stock investors whose securities are denominated in foreign currencies, when the dollar depreciates, that means that foreign currencies appreciate, that tends to be a beneficial trend for you as a foreign stock or a bond investor. It's been a headwind for foreign stock and bond investors for the better part of the decade. So, we're seeing a little bit of a reversal, but it's pretty short-lived at this point.

Dziubinski: And what about, say you own a mutual fund that hedges its currency exposure--what does this mean for you?

Benz: This means that the manager of the portfolio is trying to negate these foreign-currency fluctuations as a portion of your return. Your return as an investor in a hedged product will pretty much reflect any gains in the security prices without the fluctuations in currency that we just talked about. This is a way that some fund managers try to reduce volatility and try to make their portfolios more or less a pure reflection of how good they are at picking stocks or bonds.

Dziubinski: Christine, currency hedging is more common among foreign bond fund managers than stock fund managers, is that right?

Benz: That's right, Susan. As a practical matter, many foreign stock funds are not hedged. Many foreign bond funds are hedged into the dollar. And the idea there is that owners of bond funds typically don't want a lot of extra volatility if they can avoid it. So that's one way that fixed-income managers try to reduce the volatility in their portfolios.

That said, there are still plenty of unhedged foreign bond products as well. They will tend to be more volatile and may have higher returns over time, depending on how successful the bond manager is at selecting currencies.

Dziubinski: Taking all of this into consideration, how concerned should investors be about a falling dollar and its impact on their portfolio?

Benz: Well, I would say if you're a foreign stock investor and you own an unhedged foreign stock fund, this is going to be good news for you if this trend continues. As I said, it has been a headwind for a while now that the dollar has been appreciating relative to foreign currencies; it could be a positive. And so if you own a foreign stock fund, I think it's worth getting to know what its approach is to currency. The same goes for bond funds, where whether a fund hedges or not will tend to be a really impactful decision that that bond fund might make, that that bond fund manager might make. So that will tend to be very clearly disclosed in the fund literature--its approach to hedging. Get to know that, get to understand that, because it will have a bigger impact on your returns.

Dziubinski: Christine, thank you so much for your insights today on the falling dollar and what it means for us. We appreciate your time.

Benz: Thank you, Susan.

Dziubinski: I'm Susan Dziubinski from Morningstar. Thank you for tuning in.