(Dow Jones) There's no easy fix to the way the weakening euro is amplifying U.S. investors' losses in international stocks and mutual funds.
Investors can deal with the problem by hedging away currency risk, but the strategy can be costly in the long term.
Worries that some European nations won't be able to repay their debts has sent international stocks down far more sharply than those of U.S. companies. At the same time the Euro has lost ground, so U.S. investors that hold foreign stocks and need to translate the stocks' values into dollars have faced a double whammy. Each euro now buys only about $1.23, compared to about $1.45 in mid January.
The decline is giving heartburn to small investors, who for years have been adding foreign stocks to retirement portfolios to try to smooth investment returns through diversification. Many financial advisors recommend investors keep 10% to 50% of their stock holdings abroad.
So far this year, the Standard & Poor's 500 is down 1.5% through Friday. Meanwhile, the MSCI EAFE index, a commonly used benchmark of developed country stocks, is down 6% in those stocks' local currencies. When those returns are converted to U.S. dollars, the loss balloons to 12%.
Investors do have a few options. Some large mutual funds, such as the $4 billion Tweedy Browne Global Value fund, use techniques like trading forward currency contracts to "hedge out" the currency fluctuations. The strategy has helped the fund post comparatively strong returns amid the European debt crisis, recording a negative return of about 2.2% year to date.
Investors also can take matters into their own hands. David Darst, chief investment strategist of Morgan Stanley Smith Barney, says the company occasionally recommends investors hedge currency moves with exchange-traded funds. One strategy is to buy PowerShares DB US Dollar Index Bullish ETF (UUP), a security designed to gain value when the dollar rises. Another is to bet against, or sell short, the CurrencyShares Euro Trust (FXE), which allows them to profit when the Euro falls.
Still, right now Morgan Stanley Smith Barney is urging its advisors and clients to sit tight, in part because the options for hedging all add investment and transaction costs to holders' portfolios, putting a drag on long-term returns.
"It costs money," Darst says. "There is no super-elegant solution for the retail investor."
While currency moves can wreak havoc on investment portfolios in the short run, over time they tend to be self-correcting. A weak euro should make it easier for European companies to sell goods abroad, boosting revenue and profits and eventually giving their stocks a lift, too. That means buy-and-hold investors may be best-served by simply ignoring short-term fluctuations, says Gary Motyl, chief investment officer of Templeton Global Equity Group at Franklin Resources Inc. (BEN).