Foreign Mutual Funds Have Ace Up Sleeve

NEW YORK (TheStreet) -- The big drop in the dollar this year has annoyed tourists who must pay more for foreign wine and hotel rooms. But the weakness in the greenback has been welcome news for investors in foreign funds. The funds get a boost when overseas assets are worth more.

Since the beginning of the year, foreign large blend funds, those that invest in both growth- and value-style stocks, have returned 30%, compared with 24% for U.S. large blend, according to Morningstar. Much of the advantage enjoyed by foreign funds can be explained by the performance of the dollar, which has fallen 9% against the euro this year.

To benefit from rising values abroad, some financial advisers urge clients to buy foreign currency funds or stock funds that stand to gain from weakness in the dollar. Should you bet on foreign currencies? Perhaps. With the U.S. running enormous budget deficits, there are good reasons to think that the dollar will drop even more.

Even if there is no sudden dollar collapse, many investors may want to hold a variety of currencies for diversification. But keep in mind that forecasting the direction of currency markets can be difficult. At a time when most experts think that the dollar will fall, the consensus could prove wrong and foreign funds would suffer.

To appreciate the challenges of managing currency, consider that funds follow a variety of strategies. Most foreign funds make no effort to shield investors from currency markets. Top funds that avoid hedging include Fidelity International Discovery(FIGRX Quote) and Vanguard Total International Stock Index(VWIGX Quote).