Invest Like a Billionaire: Currency Play

photo: bradipo

If you’ve travelled internationally over the past few years, you’ve noticed how much less your dollar buys. US purchasing power has declined by 70% -80% since 2002, says Frank Trotter, the president of financial services firm EverBank. That’s a lot fewer baguettes in Paris and gelatos in Italy.

Such concerns were nonexistend prior to 1971, when the world had fixed exchange rates: currencies were a clearing mechanism, not an asset class. With the decision of the U.S. to terminate the convertibility of the dollar to gold, currencies began to be evaluated vis-a-vis their performance against other currencies (with the exception of China, which still fixes the rate of its renminbi and is an ongoing source of tension with the Obama administration). Today currencies are an asset class separate from stocks and bonds. Indeed, the foreign currency exchange market constitutes the largest and most liquid market in the world, bigger than all the world’s stock, bond, future and options markets combined. Its trading volume
tops $3 trillion — a day.

The Currency Viewpoint

“How a country’s currency is trading is a viewpoint of the world on that country,” says Trotter. It is a signal from the markets about the country’s economic strength and political positioning. When Iceland’s economy collapsed in the fall of 2008, the value of its krona dropped 86% in a three-month period. Inflation in Zimbabwe reached 89.7 sextillion percent (1 sextillion has 21 zeroes and equals 1000 trillion) in 2008 and the country abandoned printing of the Zimbabwean dollar last April. (Zimbabweans now use foreign currencies, including the South African Rand, Botswana Pula, Pound Sterling and the U.S. Dollar.)

Billionaire investors have taken huge bets on currency upticks and downturns over the years. U.S. hedge fund billionaire and philanthropist George Soros bet against the British pound in 1992, predicting it would fall after the Bank of England stopped fixing the exchange rate. He reportedly made $1 billion in one day. (Today Soros is worth $14 billion.) UK billionaire and currency trader Joseph Lewis is said to have made more than Soros on that day. (His net worth is now $2.5 billion.)

More recently, legendary U.S investor Warren Buffett expressed concern over the weakness of the U.S. dollar. “Our country has been behaving like an extraordinary rich family that possesses an immense farm. In order to consume 4% more than we produce – that’s the trade deficit – we have day by day, been both selling pieces of the farm and increase the mortgage on what we still own,” he said in 2003 when he announced that he had bought a basket of foreign currencies to profit from a coming decline in the dollar. It was the first time he ever bought a single foreign currency. Five years later, in 2008, he again bet against the U.S. dollar and made a bundle.

Despite some recent positive news on the unemployment and deficit fronts this year, Goldman Sachs analyst Franceso Garzarelli says that the U.S. economy still depends heavily on ultra-low rates — the same low rates that have led to a depreciation of the dollar since 2002.

“Unless there are policy changes, we see the U.S. dollar declining over the next three to five years,” predicts EverBank’s Trotter.

Making the Currency Play

Few people can make big currency bets like Soros or Buffet, and currency trading is a risky business. Some even argue that long-term expected returns for currencies are zero, as gains in the short-term can be erased if the tide turns over the long-term.

Another train of thought is that currency movements are often counter-cyclical to equity prices, so holding a diversified basket of currencies may help stabilize your portfolio. (That is, when a country’s stock market declines, its currency tends to go up in value — and vice versa.)

Thanks to ETFs, money market fund and Certificates of Deposit, you can readily and inexpensively own foreign currencies.

ETFs options have expanded significantly over the past few years. You can chose your own level of risk as ETFs can be bought long or short, and their performance is tied to the prevailing interest rate in the host country. However, they do not have the stability of a money market or a CD, so you should keep in mind volatility and risks of devaluation when choosing an appropriate currency or basket in which to invest.

EverBank’s Trotter recommends sticking to the G-10 currencies (which is actually made up of 11 countries: Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States). These are countries that have solid fiscal and monetary policies. In addition, countries like Canada have a strong commodity base, which is a boon to the currency. If you go further afield, stick to the same parameters. To that end, he recommends Norway and Singapore, but warns against emerging markets, which are too risky.

EverBank was one of the first institutions to develop CD and money market currency products and currenly offers a wide range of both. The money market account requires a minimum deposit of $2,500 and lets you own the currency you chose. Though the yield of the money market account is lower than that of a CD, the product is more liquid. CDs have a higher minimum deposit — $10,000 — but allow you to purchase either a single currency or a basket of currencies.

How much exposure to currency everyday investors should have is a subject of debate. While Trotter recommends allocating 5 to 15 percent of your portfolio to that asset class, Morningstar ETF strategist John Gabriel recently argued that many investors may already have all the exposure they need via their international stock and bond holdings. 

As always, be sure to consult with your financial planner or adviser (if you have one) before making any radical portfolio moves.

Tatiana Serafin, a former staff writer at Forbes, now heads Global Markets and Ideas.