NEW YORK (
) -- 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
Tweedy Browne Global Value II
. 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
, 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."
A favorite Swiss holding is
. The company is growing rapidly in emerging markets and buying back stock. Winters also likes
, a big Swiss watchmaker. Swatch products range from inexpensive plastic watches to high-end timepieces. Sales are booming in Asia.
A solid bond fund is
Oppenheimer International Bond
, which has returned 7.9% annually for the past five years, outdoing 89% of world bond peers. Oppenheimer normally keeps 70% of its assets in the developed world with the rest in emerging markets. But in recent years, the fund has had most of the portfolio in the emerging markets. Portfolio manager Sara Zervos says that developed countries are troubled by heavy debt burdens, while most emerging economies are on sounder footing.
"We feel much more comfortable with the balance sheets in the emerging markets," she says.
Zervos is particularly keen on government bonds from commodity countries, such as Brazil and Mexico. Because the economies are growing steadily, the currencies should remain strong. The emerging markets also offer tempting yields. While 10-year U.S. Treasuries yield 3.3%, comparable Mexican bonds yield 7.5%.
Another strong performer is
Loomis Sayles Global Bond
, which has returned 6.7% annually during the past five years, outdoing 72% of competitors. Besides underweighting the eurozone, the fund is steering away from Japanese yen. Portfolio manager David Rolley worries that the yen will be pulled down by budget deficits.
"The Japanese government's tax receipts cover less than 50% of expenditures," Rolley says.
Rolley likes Korean bonds. The five-year issues yield 4%, and the economy remains sound. Korea's world-class exporters are reporting booming sales to China. He is also overweight Norway and Canada, commodity countries with growing economies.
Written by Stan Luxenberg in New York
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Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.