Investors from around the world are attracted to currencies as an asset class because of the high levels of liquidity, the size of the market, the diversification benefits, and potential leverage used when trading currencies. As the most traded currency, the U.S. dollar makes up the majority of forex trading at ~85%, followed by the euro at ~40%, and the Japanese yen at ~20%. To round out the top five currencies, the pound Sterling consists of ~12% of currency followed by the Australian dollar at ~9%. Yet even with the size and liquidity of the currency markets, the currency asset class is still a big unknown to many investors and often considered too risky to invest in.

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To know how currency mutual funds can play a role in an investor’s portfolio, it is important to know how currency markets work and what the benefits are as an asset class. As an asset class, currencies are well suited for active management, they are less volatile than other assets, and are uncorrelated to the rest of the market, which gives them great diversification benefits. Liquidity and transparency are additional benefits to owning currency mutual funds in one’s portfolio.

Many investors believe that currencies are more volatile than stocks, when in fact they have been historically less volatile. Furthermore, the combination of having a low volatility and low correlation asset in an investor’s portfolio can help when other asset classes fall in value. While there are no safe assets, the diversification benefits of currencies are hard to ignore.

There are many different types of currency mutual funds, including domestic and country-specific and even emerging market currencies. While many investors may have exposure to the U.S. dollar through some type of investment, there are many foreign currency mutual funds that diversify away from the potential risks associated with the U.S. dollar as an asset class. An investor could choose to invest in the euro for example, or Swiss franc, or own a currency mutual fund that has holdings in the Indian rupee, the Canadian dollar, and the British pound.

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The benefits of currency exposure include attractive returns, hedging potential, and diversification. By investing in currency mutual funds, investors can capture the growth potential of strengthening economies and fiscal reforms. The investment can also be a hedge against your local currency in case it weakens compared to other currencies. Further, as previously mentioned, currencies have had low historical correlations with other fixed income assets and thus can enhance overall portfolio diversification.

Below are a few other reasons to consider investing into the currency market.

• Crash Resistant
  The currency market, unlike the equity market, cannot suffer a “crash” like the Great Depression or what was seen in 1987. In the currency market, any loss is offset by a gain of the counter-party.

• Low correlation
  In addition to having low correlation with other asset classes, currencies also have low correlation with each other. For example, as the euro moves up against the yen, another currency may move down or vice versa. The benefit being that investing in more than one currency can have a positive risk-adjusted return over any single currency.

• Transparency
  At any given moment, investors can easily see what the value of one currency is compared to another. This transparency helps keep bid-ask spreads narrow and the transaction cost involved in purchasing currencies low.

• Liquidity
  As previously mentioned, the currency market is the most liquid in the world and the only market that operates every single day of the year at any time of day.

• Diversification
  Currency mutual funds not only give investors exposure to a low correlation asset to other assets, they also invest in a multitude of currencies that have low correlation to each other as well, further diversifying a portfolio.

Test your knowledge of foreign markets with our Quiz – Which Country Has a Higher GDP?.

As with any investment type, there are risks when dealing with currency mutual funds:

• Political Risk
  The market may factor political risk into currencies. Political changes or instability in a country can affect investment returns and the pricing of the country’s currency in the market.

• Monetary Policy Risk
  This is the risk that a central bank may loosen or tighten the strings on its currency by stimulating the economy (lowering interest rates and weakening the currency) or try to reduce inflation by slowing the economy (raising interest rates and strengthening the currency)

• Foreign Exchange Risk
  The risk of an investment’s value changing due to changes in currency exchange rates

• Fiscal Policy Risk
  The government of a given country may decide to borrow money to stimulate the economy, or may decide to use tax-payers money to pay down the debt. In either case the effect on the currency can make it rise or drop depending on what the counterparty country’s policies are in comparison.

Any number of these can either help or hinder an investor’s returns, so do your due diligence before making any investment decision.

These are some of the most well known currency mutual funds:

PIMCO Emerging Markets Currency Fund (PLMAX)

• Total Assets: $6.29B
• Expense Ratio: 1.25%

John Hancock Funds Absolute Return Currency Fund (JCUAX)

• Total Assets: $1.96B
• Expense Ratio: 1.53%

Eaton Vance Diversified Currency Income Fund (EAIXX)

• Total Assets: $664M
• Expense Ratio: 1.10%

Lord Abbett Emerging Markets Currency Fund (LDMAX)

• Total Assets: $514M
• Expense Ratio: 0.99%

Merk Hard Currency Fund (MERKX)

• Total Assets: $272M
• Expense Ratio: 1.30%

Investing in currency mutual funds requires a different way of looking at the market compared to equities and even fixed income. Investors need to consider the risks involved, namely any change in monetary policy the country’s central bank will decide on, and the general macro environment of that country. On the flipside, currency mutual funds offer diversification benefits and that investors need in their portfolio. The limited amount of currencies can also be a benefit, keeping the selection simple. As with any investment, there are risks, but if an investor does their due diligence, it can be hard to ignore currency mutual funds as an asset class to add to your portfolio.

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