Adding Some Forex For Diversity

By Aaron Levitt | July 18, 2011 AAA

For investors, finding uncorrelated assets for their portfolios is becoming increasingly important. The Great Recession has shown that a portfolio of stocks, bonds and cash may not be enough to make to it the finish line. Taking a page out of institutional investor's playbook, alternatives such as commodities and managed futures are creeping into more and more portfolios. Funds like the iShares Diversified Alternatives Trust (NYSE:ALT) have gained in popularity as investors crave exposure to these assets. One such unconventional asset class, despite trading nearly $4 trillion a day, is often ignored by the retail set. However, this asset class could be exactly what investors need in a portfolio.


TUTORIAL: Forex Trading 101


Forex For Everybody
The currency sector remains the world's largest marketplace, trading trillions of dollars, 24 hours a day. Aside from a few traders opening margin accounts at a forex brokerage like FXCM (NASDAQ:FXCM), many retail investors exposure to the asset class has been limited. It's no wonder. The rapid-fire currency trading environment causes nearly 75% of individual investors to lose money. However, the exchange-traded fund boom has allowed investors to take advantage of the potential in currencies without much of that fast-pace margin trading risk.

And that potential for a portfolio is great. While currencies typically aren't seen as a long-term growth vehicle like stocks, they do provide many benefits to an overall portfolio. By investing in various notes, investors can increase their overall diversification. Currencies have low correlations versus more traditional securities. They provide the zig when domestic stocks, bonds and other money market instruments zag. Currency also offers investors the ability to potentially reduce or eliminate certain undesired portfolio risk or provide additional return.

The asset class also provides protection against the weakening U.S. dollar. The greenback has continued its multi-year slide. The dollar index, which measures the greenback against a basket of six major currencies, has fallen during the Federal Reserve's QE2 stimulus measures. And with the rest of the globe raising questions about whether the global financial system would be better off with an alternative world reserve currency, many analysts are predicting that slide to continue.

Finally, money market rates in South Africa are very different than those in Japan. Underlying economic factors and worldwide confidence in monetary policy have a direct effect on these rates. By exploiting that difference, investors can gain additional yield or add an income component to a portfolio.

Adding That Exposure
With nearly 30 ETFs tracking a variety of currencies and forex strategies, retail investors have plenty of ways to add that exposure. For example, the PowerShares DB US Dollar Index Bearish (NYSE:UDN) makes a single bet that the dollar will fall against a basket of currencies. But there are other ways to play the currency market.

Asia's continued rise as worldwide super has not gone unnoticed by the equities markets. However, playing the continents strengthening currency is often ignored. The Barclays GEMS Asia-8 ETN (NYSE:AYT) follows a basket of eight Asian currencies including the Indonesian rupiah, Philippine peso, South Korean won and Malaysian ringgit. So far the ETN is up around 3% for the year. For those investors looking to cash in on two BRIC superpowers in Asia, the WisdomTree Chinese Yuan (NYSE:CYB) and WisdomTree Indian Rupee (NYSE:ICN) are available.

With the variance of interest rates around the world, investors can profit by using a carry trade strategy. Essentially, an investor borrows money in a low-interest-rate currency and then invests the proceeds into higher yielding notes. Both the iPath Optimized Currency Carry ETN (NYSE:ICI) and PowerShares DB G10 Currency Harvest (NYSE:DBV) go long and short a basket of currencies from developed nations to profit from the spreads in interest rates. They both make it easy to add currency arbitrage to portfolio.

The Bottom Line
For investors looking for alternatives for their portfolios, currency remains a compelling addition. The exchange-traded fund boom has made it easy for regular retail investors to add currencies such as the Swedish Krona (NYSE:FXS) to a portfolio. Those who do, will be greatly rewarded with a host of benefits. (In a volatile market, domestic investing can be risky. Many investors choose to look overseas for diversification - but that strategy comes with its own risks. To learn more, see The Risks Of Investing In Emerging Markets.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

comments powered by Disqus
Related Analysis
  1. India Remains An Emerging Market Bright Spot
    Stock Analysis

    India Remains An Emerging Market Bright Spot

  2. Still More Gains Ahead For Semiconductor Makers
    Stock Analysis

    Still More Gains Ahead For Semiconductor Makers

  3. Major Trend Reversal Projects 15% Upside In This Downtrodden Stock
    Investing

    Major Trend Reversal Projects 15% Upside In This Downtrodden Stock

  4. Unconventional Drilling Still Has Room To Boom
    Stock Analysis

    Unconventional Drilling Still Has Room To Boom

  5. Finding An Alternative With Currency ETFs
    Stock Analysis

    Finding An Alternative With Currency ETFs

Trading Center