27 Sep 2008

Hedging Against Dollar Inflation

Although there are lots of ways to hedge against a fall in the U.S. dollar, I was inspired by this post to look at four funds in particular that seem like promising, low-cost ways for the small investor to flee the dollar, if they desire:

Starting from the last, VGPMX is a precious metals mining fund operated by Vanguard. Currently it’s closed to new investors, so you’re S.O.L. if you don’t already own shares. It’s sort of the thinking man’s alternative to actually buying gold; instead of buying the gold directly, it invests in companies that mine gold and other precious metals, and which tend to be worth more when gold is high. It would have been a good buy a few years ago, but such is hindsight.

Next up is PSAFX, the “Prudent Global Income Fund”. According to Bloggingstocks.com, it “holds mostly fixed-income securities denominated in foreign currencies. Roughly 70% of its investments were in foreign debt at the end of the third quarter, with the euro, Swiss franc, and Canadian dollar receiving the largest allocations. […] the fund concentrates on the highest-rated debt, such as government securities. And as an extra dollar hedge, 11% of its assets were recently in gold and gold shares.” Basically, it’s very similar to a “money market” fund that you might buy into through your bank or credit union, but with a more diverse set of underlying assets. (Most ‘money market’ accounts invest only in U.S. government or municipal debt.) The gold is sort of a bonus, if you like that sort of thing. Expense ratio totals to 1.28% according to Google.

The Merk Hard Currency Fund (MERKX) is similar, investing in very high-grade government debt in a variety of “hard” currencies. According to Merk’s website, it’s almost 40% Euro, 17% Swiss Franc, 17% Canadian Dollar, and 9% gold. The remainder are other currencies in smaller chunks. Their page provides a good breakdown of assets and sectors, so I won’t duplicate it here, but the biggest government debt is German, followed by Canadian and Swiss, followed by cash and gold. It’s an interesting option to be sure. The minimum investment is $2500 to play, $100 buy-ins once you’ve got it opened. (IRA minimum is $1k.) The net expense ratio listed in the prospectus is 1.3%.

But what if you want to just hold cash, rather than debt instruments? In that case, the CurrencyShares Euro Trust (FXE) might be more interesting. It’s essentially like owning shares in a very big Euro savings account. The funds are actually kept in accounts (one interest-bearing and one non-interest-bearing) with JPMorgan Chase’s London branch, and the fund generates some profit this way, although it’s less than the debt-based funds.

Owning FXE is, at least as far as I can tell, the closest that a small investor can get to opening a Euro-denominated savings account and putting cash in there, without actually going through the hassle of setting up a Euro-denominated account. About the only downside I can see is, because your funds are housed in two giant accounts with JPMorgan, you’re probably not protected by European deposit insurance in the event of a bank failure. (European deposit insurance is a bit of a patchwork at the moment at the moment, too, so it’s not really clear what would happen if things went south.)

Although you buy FXE just like any other ETF, it’s technically not a mutual fund or a commodity, nor is the operator an Investment Company. The ‘fund’ is actually a Trust, and according to the prospectus, “The Shares represent units of fractional undivided beneficial interest in, and ownership of, the Trust.” Although you buy the shares from a company called ‘Rydex Investments’, they’re not the trustee – that’d be the Bank of New York; Rydex just does the paperwork and marketing. There are some fairly ominous-sounding paragraphs in the prospectus detailing the circumstances under which the whole arrangement could be liquidated – possibly to the detriment of investors – and bears reading, although it doesn’t seem like a major risk. (At least not more than anything else these days.)

When all this legal hand-waving – I counted four legal entities to operate it, located in such diverse locales as Delaware, Maryland, New York, and London – is done, the overall effect is that you, the buyer, get an interest rate equal to EONIA less 27 basis points (0.27%), and an expense ratio of 0.40%, on top of whatever the EUR/USD happen to do.

These funds piqued my interest, so I’ll probably be doing some additional research over the next few days and reporting the results. The usual common-sense disclaimers apply to all the information here: it’s not investment advice, get a real advisor if you’re investing real money, don’t sue me if you lose your shirt.

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