The decline of the U.S. dollar has hurt many international portfolios this year, at least partly because the managers bet wrongly on the currency's path.
For the year to date as of noon EST March 16, the dollar had plunged 10.99% against the Swiss franc, 9.77% against the German mark and 9.33% against the Japanese yen.
This steep drop in the dollar - which normally benefits international investors - has surprised some investment managers, who had expected a dollar rally. In some cases, their miscalculation contributed to significant underperformance compared with the indexes so far this year.
According to Morningstar Inc., Chicago, year-to-date through March 10, an average of 139 world bond funds (data on strictly international bond funds weren't available) returned -0.05%, compared with a 6.98% rise in the Salomon Brothers World Government Bond Index.
A sizable amount of the index's gain appears to have been derived from the dollar, because in local currency terms, the index only advanced 3.03%. Through March 10, the Salomon Brothers World Government Bond Index, excluding the United States, was up 8.54% in dollar terms, but only 2.36% in local currency terms.
On the international equities side, according to Morningstar, an average of 287 foreign stock funds posted a total return of -9.26% year to date through March 10. That compares with a -3.6% return - without dividends included - in the Morgan Stanley Capital International Europe Australasia Far East Index. (Data on EAFE's total return through March 10 were not available.)
Jeanine Magill, a Morningstar analyst, said among the world bond funds, a misjudgment on currency "has probably been the biggest contributor to the funds' decline." For international equities, however, this year's bad performance "may be more equally (blamed) on a misjudgment about currencies and about country (including emerging markets) allocations. International equity investors have had more (inclination) than bond investors to go into less developed markets,"she said.
Such misjudgments have been taking their toll.
At Scudder, Stevens & Clark, New York, the departure of Larry Teitelbaum, formerly lead portfolio manager of the Scudder International Bond Fund, reportedly resulted from the poor performance of the Scudder International Bond Fund, caused in part by incorrect bets on the direction of the dollar.
According to published reports, the Scudder International Bond Fund was down 2.7% in the year to date through March 13.
A Scudder spokeswoman would not discuss Mr. Teitelbaum's departure.
But even before this year, at least some managers have been betting incorrectly in the foreign exchange markets. Some pension funds also are unhappy with the performance of currency overlay management - and perhaps for good reason. In the first two months of this year, the median money manager in the FX Perf Universe of currency management, a program run by InterSec Research Corp., Stamford, Conn. underperformed the FX Perf Index. During that period, the median return of participants in the program was 2.2%, compared with a 2.9% rise in the FX Perf index.
For the full year in 1994, the differential was even more pronounced. The median return of 8.2% was 170 basis points below the 9.9% rise in the index, according to InterSec data.
According to fund trustee Hugh Brown, the Illinois Teachers' Retirement System, Springfield, in January terminated currency manager RXR Capital Management, Stamford, Conn., because of inadequate performance.
Outside sources familiar with the situation at Illinois Teachers' claimed the fund wanted to obtain incremental return - not just currency protection - from the manager, but this incremental return did not materialize. This claim could not be verified because fund officials did not return calls and Mr. Brown did not elaborate on the matter. Illinois Teachers is now conducting a search for currency managers.
On the other hand, Richard Rose, chief executive officer of the $2.1 billion San Diego County Employees' Retirement Association, said that fund's currency program has worked.
The fund has two currency overlay managers, OSV Partners and FX Concepts Inc., who together handle the currency component of the fund's $400 million of non-U.S. equities. A year ago the mandate was changed to allow the currency managers to try for enhanced returns, not just asset protection. That gave them leeway to take positions in the deutsche mark and yen that helped blunt some of the effect of the Mexican peso's devaluation.
Ronald Liesching, a partner of Pareto Partners in London, points to the range of shocks affecting markets - the earthquake in Kobe, Japan; the Mexican peso's devaluation; the collapse of Barings PLC; and the derivatives fiasco in Orange County, Calif. As investors assess these disasters in different ways, they are "coming up with radically different conclusions" about how to handle them.
In its currency strategy, for example, New York's MacKayShields Financial has been light on dollar hedging for non-U.S. portfolios. It has, however, made an asset strategy shift this year out of the equity markets of Germany, Switzerland and the Netherlands where the higher interest rates and strong currencies could take a toll, said Michael Perelstein, the firm's international investment director.
But PanAgora Asset Management has a different view on the dollar. Because its quantitative model expects a strengthening of the U.S. currency, PanAgora has its U.S. international investment clients hedged back to the dollar. That strategy runs counter to current trends, so PanAgora is "keeping close contact with clients" to explain the analysis underpinning the model's assumptions, said Clive Lang, the firm's chief investment officer in London.
When will the dollar firm? Even currency experts eschew making any firm predictions. William Ferrell, president of Ferrell Capital Management, Greenwich, Conn., predicts "the dollar will probably go down further this year. It's likely to rebound only when (the market) starts to see an improvement in the U.S. trade deficit and (when foreign investors regain) confidence they can buy U.S. investments and get value for them."
Wilbur Kim, director of Record Treasury Management, Windsor, England, expects it will be some time before the dollar will register a "cyclical rise. It's a matter of (calendar) quarters, not months," he said.
But Pareto's Mr. Liesching expects a change in the dollar's path within the next six months.
