NEW YORK ( TheStreet) -- With the U.S. economy showing signs of life, the dollar has been strengthening against the euro. That's good news for U.S. tourists who can now afford to buy more souvenirs in Paris and Rome. But shareholders in foreign funds have less cause to cheer. For American investors, the value of European stocks drops along with the cost of French wine. So returns of many international funds have been penalized by the fall in the euro.
To appreciate the impact of the currency shift, compare two sister funds -- Tweedy Browne Global Value (TBGVX) and Tweedy Browne Global Value II (TBCUX). Both funds hold similar stocks, but Global Value hedges its currency exposure so currency moves have little effect on returns. Global Value II is unhedged, leaving shareholders exposed to shifts in currency markets.
Protected from the effects of the falling euro, Global Value returned 15.4% during the past 12 months and outperformed 96% of its foreign large value competitors. Meanwhile, the euro hurt Global Value II, which returned 8.6% during the past 12 months.
Seeing the recent results, some investors may be inclined to buy Global Value. But keep in mind that currency hedging doesn't always boost returns. Throughout most of the past decade, the euro strengthened against the dollar. That gave unhedged foreign funds an advantage over Global Value, which trailed most peers from 2002 through 2007.Instead of fully hedging currency exposure, most investors should diversify, holding positions in the dollar and other currencies. That way you can avoid being whipsawed by any big moves in currency markets. An easy way to hold foreign currencies is to buy stock or bond funds that invest abroad and do not hedge. When an unhedged fund buys a Korean stock, shareholders obtain a position in the Korean currency. A broadly diversified choice is Wintergreen (WGRNX), which has returned 7.2% annually for the past five years, outdoing 95% of peers in the world stock category. Portfolio manager David Winters steers away from holdings in weak currencies. Lately he has been avoiding stocks in the eurozone. "The euro is a sick currency," he says. "I would rather own Swiss francs. Switzerland is solvent and well-run."