Morningstar Advisor - Fall 2007 - 43

Dollar Will Go Up; Dollar Will Go Down It’s seems like an article of faith these days that the dollar will continue to weaken. But the past isn’t always prologue. Remember the strongdollar 1990s, and the euro’s 1999 launch. When that new currency lost value, pundits were quick to write its obituary. Canadians were mourning their weak “loonie” in the late 1990s as well. Look at it now! There’s an old trader’s adage that currency forecasters exist to make the weatherman look good. Lots of factors drive currency movements—interest rates, trade and investment flows, fiscal policy, and plain old speculation. And these days, opinion on the dollar is split. Bill Gross, the PIMCO bond king, and Warren Buffett remain two of the most outspoken dollar bears. They point to the “twin deficits”—the budget deficit and the trade deficit—and conclude that our tendency to live beyond our means is dooming our currency. Then, there are the contrarians who believe the dollar’s dive has gone too far. David Samra, manager of Artisan International Value ARTKX, said in mid-2007 that he was considering putting on a currency hedge for the first time in his fund’s history. David Herro, Morningstar’s 2006 International Fund Manager of the Year, said last summer that he was hedging the British pound exposure of Oakmark International OAKIX in part because the high price of a Big Mac in Britain tells him the pound is overpriced. The Best Ways to Get Currency Diversification asset class: foreign-bond funds. T. Rowe Price, Oppenheimer, PIMCO, and Loomis Sayles all offer good options that invest mostly in developed-market debt, as opposed to emerging-markets bonds, which are usually dollar-denominated. Just as widening your opportunity set is a good idea on the equity side, why not get exposure to a portfolio manager who plays yield curves around the world. In this asset class, currency is an even bigger driver of fund returns, so long as the fund isn’t hedged. Finally, keep in mind that even if all you own is a plain old foreign-equity fund, you’ve got currency diversification built in to your portfolio—so long as that fund is unhedged. No less an investor than Buffett decided that direct currency bets were too tricky, so he’s focusing instead on buying foreign companies. After all, Buffett’s main motivation is simply to find the world’s best investments. K Dan Lefkovitz is a mutual fund analyst with Morningstar. Herro had another insight: Currency effects tend to even out over the long term. He advised that investors simply not worry about them. As a contrarian, Herro no doubt feared that investors would take action about the dollar at precisely the wrong time. Consider this if you’re tempted to wade into the foreign exchange market, open up a foreign currency bank account, or buy into the new breed of mutual fund and ETF springing up to help you take bets on the dollar’s continue decline: You might be buying into strong currencies with weak dollars. Investors might do better to discover a new Mark Weber, Analyst LONDON My wife is British and has had an account in good standing at a large British bank for 20 years. When we relocated to the United Kingdom last year, I assumed that having my name added to her account would be a piece of cake. I couldn’t have been more mistaken. Before I could withdraw funds from the account— they were more than happy to deposit my paychecks—I had to jump through hoop after hoop to keep the bank in compliance with Britain’s tough anti-money-laundering laws. The process took weeks. After speaking to colleagues, I know my experience wasn’t an isolated incident. What does any of this have to do with investing? Well, quite a bit, actually. My bank would have to really step over the line before I’d consider moving my account to a rival bank. Besides the hassle of just opening a new account, I’d have to arrange for my paycheck to get deposited directly in the new account and change all the automatic bill payment facilities I’ve established with various utilities. These switching costs give banks considerable leeway when it comes to raising fees or tacking on new charges, and they are one of the key reasons we think that most of the U.K.’s large banks have wide moats. Bank fees, especially those levied on overdrawn accounts, have drawn a lot of scrutiny over the past few months from British consumer groups. We think the banks’ wide moats are intact, however, and expect them to continue generating healthy fee revenue from accounts for the foreseeable future. Customer pain, however, can lead to investor gain. In the case of U.K. banks, the high switching costs help the companies generate handsome returns on equity. Thanks in part to the turmoil caused by the credit crunch, two of the large British banks are trading at very attractive prices. Barclays PLC BCS and Lloyds TSB Group PLC LYG currently trade below our fair value estimates, while we think HSBC’s HBC shares are fairly priced. Now that Barclays has abandoned its ill-conceived bid for Dutch bank ABN AMRO ABN, we think its shares are particularly attractive. Dispatch From: Banks Have Built-In Advantages MorningstarAdvisor.com 43

http://MorningstarAdvisor.com

Morningstar Advisor - Fall 2007

Table of Contents for the Digital Edition of Morningstar Advisor - Fall 2007