One of the first elements of portfolio construction is the allocation of capital between stocks, bonds and cash. I believe the cash part of that equation is about to undergo some serious evolution in the coming weeks, thanks to some innovations from the folks at Rydex Investments.Last December, Rydex listed the Euro Currency Trust ( FXE). Each share of the Euro Currency Trust equals 100 euros. As early as next week, Rydex will list six more currency ETFs, covering the British pound, Australian dollar, Canadian dollar (the Loonie), Mexican peso, Swedish krona and Swiss franc. Accessing the foreign exchange market has been difficult and imprecise for individual investors, but these new ETFs make it much easier. There are many reasons the dollar could weaken over the next few years: The U.S. has large and growing current account and budget deficits; there could be less demand for U.S. dollars as various countries consider diversifying their currency reserves; and there is the possibility that certain commodities could trade in euros as well as in U.S. dollars. These concerns guarantee nothing about the future direction of the dollar, but they do suggest a weaker dollar. A weak dollar is easily hedged in an equity portfolio with foreign stocks and in a bond portfolio with foreign bonds (more like a foreign bond fund), but what about the cash portion of a diversified portfolio? If you are willing to put a portion of your equity portfolio in foreign stocks, why not put a portion of your cash in foreign currencies? That's where I believe the new currency ETFs can come into play. If you have never thought about investing in currencies, your initial reaction might be that they are too risky. But like any investment product, currencies can be risky or conservative; it depends on how they are used.
Make sure your expectations are realistic. Typically, currencies do not provide long-term growth, but remember that this is cash, so it is targeted for a part of the portfolio that is not expected to grow. The goal here should be protecting your purchasing power, not getting hot growth stock-style returns. To that point, I would suggest these be viewed not as conservative equity plays but aggressive cash plays. I believe this is an important distinction to make. It's also important to be aware of some of the nuances of the currencies that underlie the ETFs due to be listed. Both the Canadian and Australian dollars are considered commodity currencies, and these can be great diversifiers because the U.S. is a service-based economy. Commodity-based and service-based economies tend to be at different points in the economic cycle. Also note that Canada's proximity to the U.S. may make for a tighter correlation between the greenback and the Loonie than the greenback and the Aussie. The Swiss franc's role (perceived or otherwise) in the world order is as a safe haven. The Swissi probably would appeal to everyone-in-the-bunker types. Fundamentally, Switzerland is growing, albeit slowly, and the Swiss central bank is in the early stages of a tightening cycle. The Mexican peso looks like the most volatile currency of the bunch. It represents an emerging market. Investors considering this currency trust should be attuned to concerns that an extreme leftist candidate could win the presidential election in July and that Mexico may not be able to get new oil fields up and running very soon in the face of concerns about dwindling reserves. The ETF likely to have the lowest volume, the one for the Swedish krona, could turn out to be the best performer. Sweden is in the early stages of a tightening cycle, has a healthy current account surplus and exports a lot of timber. Rydex is targeting June 20 for these funds to start trading. Although I got a "no comment" response from a Rydex public relations representative when I asked if there will be more currency ETFs coming in the next few months, I believe we're likely to see them. The yen and the Singapore dollar seem like logical additions to the product line.