The dollar’s never had so many influential friends. The central banks of Brazil, Chile, Colombia and Peru have been buying it. So have the central banks of China, South Korea and Malaysia. Ditto for Russia, Turkey and South Africa.
These august institutions are obviously not vacuuming up greenbacks because they think they’re a great investment. On the contrary, they’re doing it to slow the rise of their own currencies against the dollar, thereby hoping to protect exports and jobs.
How’s that working out so far? Well, the dollar is near its 52-week lows against a range of global currencies, from its Canadian and Australian namesakes to the likes of the Korean won and the Peruvian nuevo sol. It’s at a 13-year low this week versus the Taiwan dollar and the Malaysian ringgit.
I normally steer clear of currency speculation; it’s too hard to get right and the volatility’s too low to make much money without employing leverage. But when you have a bunch of politically- and parochially-motivated actors trying to counteract the tides of global trade in so halfhearted a manner, often working at cross-purposes, the urge to take the other side of their trade is hard to deny.
There have not been many successful government interventions in free-floating currencies: Ask the British, the Japanese or the Swiss. None of the emerging-market central banks is doing anything on the scale of those past failures. For the most part, they’re just trying to make sure their currency doesn’t appreciate significantly faster against the dollar than those of its neighbors and global competitors.
As policy responses go, this is the equivalent of scratching a persistent itch: Irresistible but ultimately unrewarding. The emerging-market currencies are rising because their central banks are raising rates to fight inflation. It is those higher rates that attract speculative dollars, thereby raising the value of local currency. But when the central bank intervenes by buying dollars it adds to the supply of local currency, potentially boosting the very inflation it’s trying to control. Or it can “sterilize” the intervention by selling a comparable amount of domestic debt. But that would tend to push up yields, thereby sucking in more dollars.
With a setup like that, what gambler isn’t tempted to play Soros? It’s very hard in the modern world to control capital flows into the fastest-growing, highest-yielding areas. And differentials are currently high enough that failing to take advantage feels like borderline negligence.
The most obvious response would be to purchase the higher-yielding currencies temporarily restrained by intervention directly (thank you notes to the respective central banks for keeping one’s cost basis down are strictly optional.)
But most of us are not currency traders just yet. And while it’s possible to buy certificates of deposit denominated in foreign currencies, the rates on offer are no match for those in the local markets.
Fortunately, investors have other choices. Here are a few that seem especially attractive at the moment.
The WisdomTree Dreyfus Brazilian Real Fund (BZF) has a trailing 12-month yield of 12.5%. The WisdomTree Dreyfus South African Rand Fund (SZR) yielded 14.8% in 2010, and returned 19% overall. And it’s not as if the yields in those markets have withered since the new year dawned. In fact, Brazil has already hiked its benchmark rate by 50 basis points to 11.25%, with more in store.
For those seeking broader exposure to emerging-markets currencies, the WisdomTree Dreyfus Emerging Currency Fund (CEW) combines a dozen currencies from the Chilean peso to the Polish zloty and the new Israeli shekel, though it has a trailing yield of “only” 3.8%. A one-year dollar CD earns around 1.3% these days.
Rate hikes can be traumatic for an economy and even more so for investing sentiment. Just look at the recent action in GOL Linhas (GOL), the high-yielding Brazilian airline, or in emerging-market bond funds, most of which are in the red so far this year. Rising rates and rising inflation are bothersome for shareholders and bondholders alike. Currency ETFs avoid these risks by investing short-term. As long as rates rise they benefit doubly, because yields rise and because those higher yields attract more speculators, boosting the currency.
There are other issuers in this space besides WisdomTree: For example, Barclays has seen fit to package the Chinese, Hong Kong and Singaporean currencies with those of Saudi Arabia and United Arab Emirates. Somehow, that concoction has not caught on with the public, however.
For those willing to take on more risk, there are equity and debt options that combine solid yield with the potential for capital gains (as well as losses.)
The Aberdeen Chile Fund (CH) is a case in point, losing 17% over the last three months even after accounting for dividends. Still, it did return 46% including dividends last year. And with Chile’s economy continuing to boom, that 10% trailing yield from the fund’s (mostly equity) holdings does offer a margin of safety. Chile is Latin America’s most advanced and one of the world’s best managed economies. Copper accounts for 17% of exports, and its steady rise in value provides a tailwind.
The Templeton Emerging Markets Income Fund (TEI) holds emerging bonds, and has a trailing 12-month yield of 7.6%. It ventures far off the beaten path into the debt of Ukraine, Kazakhstan and Iraq (all of them energy or agricultural plays). But this is largely a bet on credit quality, because 77% of the portfolio’s currency exposure is in the US dollars. The similarly yielding Morgan Stanley Emerging Markets Domestic Fund (EDD) buys all of its debt in local currencies, and sells at a 9% discount to net asset value. But that’s a pretty typical markdown for this fund, and its performance has lagged behind TEI’s of late.
The GMO Emerging Country Debt III Fund (GMCDX) has outperformed 99% of bond funds tracked by Morningstar over both a one-year and a 15-year spans by focusing on lower-quality issues of longer duration. It has a trailing yield of 13.3%. Top holdings include Argentina, the Russian gas monopoly Gazprom, Congo, and Venezuela.
The TCW Emerging Markets Income I Fund (TGEIX) yields 6.4% and has a five-star Morningstar rating and a great performance record. After losing 13% in 2008 it returned 45% in 2009 and 21% last year.
We haven’t even gotten to the particular high-yielding emerging-market equities. That’s a whole other column for another day. Right now, the currencies of countries like Chile, Indonesia and Brazil would seem to have less risk attached to them than either stocks or bonds. That’s what makes the BZF and the SZR so attractive. They pay well those willing to bet on the long-term trend and against haphazard attempts to slow it.