How to buck a downward trend

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Down on the dollar? Join the club. Bearish views on the greenback abound among economists and traders and a new mutual fund is launching to help investors get in on the game.

Trading currencies has traditionally been a field dominated by bank professionals dealing in millions per trade, particularly in the US where deep home markets have meant many investors have not felt the need to invest overseas.

But that has changed with the weakening of the dollar in recent years and the shift in investment fashion towards all forms of divers­ification, including overseas investments.

“If you own dollar assets you are taking a position on the dollar, whether you like it or not. Once you realise this, you can’t ignore it,” says Daniel O’Neill, president and chief investment officer of Direxion Funds.

The ways for investors to gain exposure to, or manage, currency risk have mushroomed in recent years, from day trading platforms to exchange-traded and mutual funds.

The Direxion Funds 2.5x Dollar Bear fund aims to produce daily investment returns before expenses of 250 per cent of the inverse of the performance of the dollar index. In essence, this means the fund will be positioned for the index to fall and plans to profit through buying and selling futures on the dollar index and using swap contracts.

The index in question is compiled by Reuters and futures based on it have been offered on the New York Board of Trade since 1985. It is not a strict trade-weighted index and currently it consists of a 57.6 per cent weighting in the euro, 13.6 per cent in the Japanese yen, 11.9 per cent in sterling, 9.1 per cent in the Canadian dollar, 4.2 per cent in the Swedish krona and 3.6 per cent in the Swiss franc.

Direxion, known as Potomac until earlier this year, typically launches funds in bear and bull pairs. A dollar bull fund is due out later this year. “We are coming out first with the bear because we have a particular view that there is likely to be some pressure on the dollar,” O’Neill says.

Until recently, the pressure was there to see. Against the euro, the dollar had lost 8.9 per cent this year, falling from $1.182 to $1.297 earlier this month. Against the yen, (the next most-traded currency pair after dollar-euro) the greenback had given up 7.5 per cent.

The dollar index followed suit, losing 6.9 per cent to its May low. Since then, it had been holding relatively steady but a rally over the past week saw it gain almost 3 per cent, now down 4.4 per cent this year to date.

Looking over a slightly longer time horizon, this might seem a strange time to get bearish on the world’s reserve currency, since the index is already 29 per cent below its July 2001 peak and is currently not far off its 2004 nadir of 80.53.

Since 2004, the dollar has been buoyed up by rising interest rates, a classic currency strengthener, since higher yields encourage investment inflows. But the Federal Reserve is believed to be nearing the peak of its rate increasing run while other central banks are only beginning, making the dollar relatively less attractive than it was.

Market thinking is that the dollar’s interest rate support will begin to fade. Attention has already begun swinging back to the structural woes that lay behind the dollar’s last big slide, namely, the current account deficit. The US has a large trade deficit, the result of imports rising at a faster pace than exports, but the dollar has been buoyed up by capital inflows from investors keen on America’s deep capital markets.

The danger, say dollar bears, is that demand for US assets could decline, implying less demand for dollars, and the greenback’s value will fall accordingly. For economists, this is what should happen because the deficit, at about 7 per cent of gross domestic product, is considered unsustainable, meaning the dollar should at some point fall until its value is low enough to boost US exports while curbing imports by making them more expensive. If you buy this argument, then the Direxion fund could make a lot of sense as a way to turn it into money.

This is a popular time to be launching currency products. For those prepared to take a more specific view, Rydex is launching six new currency related exchange-traded funds. It launched the first-ever, the Euro Currency­Shares fund, late last year and has since attracted a $700m in assets.

This time the manager is to offer funds covering sterling, the Australian dollar, the Canadian dollar, the Mexican peso, the Swedish krona and the Swiss franc. Again, they make a sensible vehicle for those wanting to try taking a bet that was previously restricted to the professionals.

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