Friday, January 9, 2009

Asset Allocation Problems: foreign currencies, stocks and bonds

I did not buy any platinum today.

Foreign currencies have a place in my asset allocation. They just do not have a place now. Generally, my maximum allocation to foreign currencies would be 2% of my investable assets, as defined in an earlier post. VANGUARD ASSET ALLOCATION: IS VANGUARD PROUD? MORE ON VXD The current allocation is just 30 shares of FXA which is not a measurable allocation. I jettisoned the foreign currencies in 2007 based solely on one consideration, a continued rally in foreign currencies for more than five years was viewed as not probable based on a historical patterns, and I believed that I was pushing my luck staying in them. Prior to the last few months, the ETFs for the Aussie dollar (FXA) in particular, and the one for the Canadian dollar (FXC) to a lesser extent, were paying decent dividends since the interest earned was tied to the amount those currencies would earn from overnight deposits. This has pretty much ended as central banks in Canada and Australia have lowered their equivalents to the Federal Reserves federal funds rate, making short rates unattractive to me in most developed world currencies. This takes away one advantage in investing in foreign currencies. As a result, the foreign currency ETFs have simply become a play against the U.S. dollar. This requires me to have more certainty about the course of the dollar versus other major currencies, and I simply do not have a strong opinion either way now. It would help some if I could be paid 7% for holding Aussie dollars but that is not happening now.

The column by Jim Jubak concerning the U.S. dollar is worth a read. No crisis for the US dollar -- yet - MSN Money - Jubak's Journal He opines that the dollar will gain value this year and start a decline in 2010, basing his 2009 prediction on a continued flight to the perceived safety of U.S. assets, the belief the U.S. dollar is less bad than the alternatives, and that the U.S. economy will start to recover before the rest of the world. Trying to guess the movement in a currency may be a fool's errand. I suspect that Jubak is making the case for what happened in 2008 rather than what is likely in 2009. However, good arguments could be made either way at least for the next few months and it is that uncertainty coupled with the lack of dividend compensation for the risk which keeps me on the sidelines for now.

When doing an asset allocation, I will have some foreign bond and stocks whose value has some direct correlation to the rise or fall of the dollar. The most direct investments tied to a decline in the dollar would be the currency ETFs that I previously owned and sold last year, except for a small 30 share position in FXA. This was an asset allocation move based primarily on the belief that a continuation of a bull market in foreign currencies was a stretch, so it was just best to sell my direct exposure to the decline in the dollar which consisted of most of my FXA holding and all of FXC, FXF and emerging market currencies including the Brazilian Real. I have not bought those positions back. My reluctance is not because I agree or disagree with the assertive declarations that Jubak makes for the dollars advance in 2009. It is more that I am sufficiently uncertain about the prospects of a continued dollar rise that I will not now re-establish a material allocation in foreign currencies. I am certainly a long term bear on the dollar now but see no urgent reason to make a short term play against it now in my asset allocation.

A contrary argument is presented in this linked article.

For now, given the uncertainty, I simply reestablished a position in BWX, an ETF for foreign government bonds, that gives me some exposure to foreign currencies. The reason for choosing it is that many of the foreign government bonds in this ETF may increase in value due to the worldwide slashing of interest rates which are making bonds around the world more attractive to income investors as well as a flight to safety, for this ETF contains government debt issues from many developed countries with a large allocation to Japanese government debt. I am also keeping my investment in WIP steady which is the ETF for inflation indexed foreign government bonds.

So, just for myself, I have answered two questions about foreign stocks, bonds and currencies. I was willing to buy ETFs containing foreign government bonds and have done so. I am not willing to buy the currency ETFs now. This leaves foreign stocks. The most difficult decision is when to buy foreign stocks again. Part of their appreciation for a U.S. investor prior to 2008 was linked to the depreciation of the U.S. dollar against most currencies. This depreciation would cause, in itself, a dramatic rise in the value of foreign stocks denominated in euros, Canadian dollars, or any other currency rising against the dollar. The foreign stock markets were decimated in 2008, in some cases suffering worse declines than the U.S. but a foreign stock portfolio unhedged against currency risk would have accelerated the amount of losses for a U.S. investor. My allocation to foreign stocks was drastically cut in 2007. Except for a purchase in 2008 of shares in the Swiss Helvetia fund (SWZ), I have yet to step my toe back into the water. I eliminated all but 150 shares of the Matthews Pacific Tiger Fund, 100 shares of an emerging market fund, 100 shares of what used to be called the Julius Baer International Equity fund, a small position in international small caps and somewhat larger positions in two closed end funds ETW and EBI. For me, that is as close to nothing as I could get.

While my decision to reduce foreign stock exposure by over 90% was correct when made, it also creates a new problem of when to start buying the position back. I can not rely on my VIX model for U.S. stocks to tell me what to do. It is nowhere near a buy signal for U.S. stocks. I do not have any high level of confidence that 2009 will be a down year for the dollar so I might not have the tail wind of rising foreign currencies as I did for about five years before 2008. So, this is a quandary and I do not know what do about it. So, I have been doing nothing about it. I did tip toe into VWO and then quickly jettisoned it. I am leaning now to buying back VEU, which is the Vanguard All World ex US ETF, which would give me a very broad exposure to all foreign stocks at a very low cost. I jettisoned it in May 2007 at around 52 and have not touched it since then. It is now at 31.49 as of Friday's close. VEU: Summary for VG FTSE ALLWD US ETF - Yahoo! Finance
If I buy that one again, it will be a chicken move back into foreign stocks. But, sitting here in the SUV capital, I just see a worldwide recession and no ray of light anywhere. It would be more of a hope and prayer investment. Another approach would be to start adding $500 a month to BJBIX, which is the fund formerly know as Julius Baer now called Artio International Equity. I have talked myself into doing that. Another ETF that I sold earlier at much higher levels is the one for Canadian stocks, EWC, and I like to have some exposure to that market. So far now, I will just pick a spot to add 100 of VEU and 100 EWC until I decide it is at least safer to up the allocation to a meaningful number. Am I in a hurry to do a nibble on VEU and EWC? I do not see a need to be in a hurry right now. Maybe, I will allow one of the young ones to make the decision for me.


I am not a financial advisor but an individual investor trying to navigate my way through a difficult market. In these posts, I am acting as an unpaid financial journalist and an occasional political commentator. I am also aggregating financial news stories that I view as important and providing any reader of these posts, assuming there are more than a couple, with links to those articles, sort of a filtered, somewhat intelligent, free search engine. Any discussion made by me of particular securities is not a recommendation to buy or to sell. Trade at your own risk. Consult with your financial advisor prior to making any purchase or sale. I will try to identify my sales too but it may take a few minutes after I implement them to create a post explaining my reasons. The sale may before or after the post. Before buying or selling any stock, even one recommended by a trusted financial advisor, please research it and make up your own mind which is what I always try to do. Research would include reading reports, reviewing financial records, earnings estimates, sec filings and prior earnings releases and news. In this post, and all others by me, I am merely describing my reasons for purchasing or selling securities, and the potential pitfalls that I identified prior to purchase or the reasons for a sale. The securities mentioned in this and all posts written by me may not be suitable for others based on their unique financial position and risk profile. Always read the prospectus before buying a Trust Certificate, bond, preferred stock or other bond or bond like investments. Information contained in my posts has been obtained from sources believed to be reliable but cannot be guaranteed. These posts by me do not constitute investment advice, nor shall they be construed as a guarantee of future results, or as an offer of any transaction in securities. All content in these posts is provided for informational and entertainment purposes only, and it is a form of entertainment for me.

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