Do Foreign Stock ETFs Take Advantage of the Falling Dollar?

by Leslie McClintock

With exchange traded funds, or ETFs, investors can get broad exposure to the fortunes of the equities or bonds of a country or an entire region with a single purchase. They can also trade throughout the day, without having to wait until net asset values get calculated at the end of the day like a mutual fund does. These can be particularly powerful investments when the dollar is declining relative to other currencies.

Currency Risk

Currency risk is simply exposure to the uncertainties of the fluctuations of currencies, relative to one another. Some investors avoid currency risk and foreign currency-denominated investments altogether, or eliminate it through hedging strategies. Other investors embrace currency risk, viewing as another layer of diversification, and a potential source of gains.

The Declining Dollar

As of early August, 2011, the dollar had declined by 15 percent against the euro over the preceding twelve months, and 30 percent over the previous 10 years. The dollar also declined relative to other currencies, such as the yen, the pound and the Australian dollar, as well, over the same period.

Foreign Currency Denominated Investments

When you buy an investment abroad on the local market you must generally convert your dollars to the local currency at the going exchange rate that day. After that, the dollar may rise or fall relative to other investments. The dollar has been falling, lately, compared to many other currencies -- which means that your money will buy more dollars later, when you convert your currency back into U.S. dollars. So even if the assets in your ETF, valued in local currency, remain flat, you will still profit in dollar terms when you convert your investment back into dollars. Of course, the reverse is also true; if the foreign currency falls against the dollar, that will work against you, either cutting your gains or increasing your losses.

Effects of a Falling Dollar

A weak dollar, relative to other currencies, is actually good for some sectors of the U.S. economy. Because other currencies buy more in the U.S. when the dollar is weak, the declining dollar tends to favor manufacturers, exporters and areas that attract a lot of foreign tourism. The weak dollar therefore tends to encourage job formation. A weak dollar also makes imports more expensive for Americans.

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