Gains in Dollar’s Decline
Merk Hard Currency Fund, Merk Asian Currency Fund
global > >
Nov 24, 2008
52 Week HL
34.75 - $28.23
Oct 06, 2009
Q: What is your investment process and what are your views on leverage in the fund?
A : In our Hard Currency Fund, we focus on the countries pursuing sound monetary policies. Those are currently the Western European countries, Canada, and Australia. We invest in short-term money market instruments in these countries.
We are not a money market fund; we are a hard currency fund. That is kind of a special case of an international bond fund. We invest in cash instruments and what we are trying to do is we are trying to pass on the swings of the U.S. dollar onto investors without using any leverage in the fund.
Typically, when you think of currencies, you think of speculation of betting 100-to- 1 or 10-to-1 on any moves. We do not do that. We take the U.S. dollar into a basket of hard currencies in our Hard Currency Fund. In that fund, we try to invest in short-term money market instruments and, in the current environment, we primarily buy treasury bills. These are treasury bills issued by the U.S. and other governments.
Q: How is the Asian Currency Fund investing different from Hard Currency Fund?
A : In our Asian Currency Fund, we do something similar with a basket of Asian currencies; however, we do not believe that Asian central banks necessarily pursue what we call a sound monetary policy meaning the central banks there are motivated by other factors. They like to keep their exports to the U.S. growing; they like to grow their economies, they are more volatile in their monetary policy and, as a result, we do not think that Asian currencies have a place in our Hard Currency Fund. Infl ationary pressures may be significant in Asian countries and Asian countries may not be able to rely on exports to the U.S. in the future as much as they have in the past because of the trouble in the U.S. We believe those circumstances may linger around for a while.
We believe there is certainly a speculative potential in Asian currencies to appreciate. In order to take advantage of that opportunity, we invest in the Asian currencies. In most countries, you cannot buy the money market instruments or you do not want to buy them, so we use forward contracts to get exposure to these currencies.
We do not use leverage or trade in and out of these currencies. We try to give investors the movements of the currencies. In Asia, we have an allocation in the past of over 40% to the Chinese yuan so our fund is seeking to provide one avenue to allow investors to participate in a potential appreciation of the Chinese Yuan.
In the second quarter of 2008, foreign investments flows in the U.S. were down 94.5%. That was mostly due to foreign investors being scared of the governmentsponsored entities, Fannie Mae and Freddie Mac. Because of that, the U.S. Treasury engineered the quasi nationalization of the gdp and that fear stopped. At the same time, this deep discomfort has been placed in central banks throughout the world notably in Asian central banks and everybody is nervous about how the United States will proceed in it policies.
The types of government actions we have seen used to try to stabilize the U.S. economy in our interpretation have the potential of being highly inflationary. If the government tries to rescue the banking system, a consumer, the automotive industry, or the airline industry, what the Federal Reserve should be raising interest rates to clean up the extra liquidity added to the markets. However, we do not believe that the current composition of the Federal Reserve is likely to do that. The last thing the Federal Reserve would want is high interest rates that will cause further pressure on potential homeowners and with that on the housing market.
Q: How many currency exposures do you have in the Hard Currency Fund? What kind of diversification or allocation do you do?
A : We are considered a non-diversified mutual fund, which means we are not allowed to take more than 5% of our assets in any one security. We invest in fixed income securities and commodities but not in equities. Typically, when we have more than 5% of our fund in a security and a maximum of 25% it would be something like a german treasury bill or some other government obligation. We are allowed to buy corporate debt and we may do so. We publish our allocation every month on our Web site and provide both the currency allocation all of our holdings, including the derivative exposure if we have any.
The allocation we have may change, but we have always had a significant exposure to the euro, for example after the summer of 2008, we have tended to have above 35% exposure. I cannot say what we will invest in, in the future.
We have had significant exposures to the Swiss Franc and smaller exposures to the currencies of norway, Sweden, and Britain. We have also had a significant exposure to the Canadian dollar. In the beginning of 2008, we shifted significant exposure from Australia to Canada. They are both currencies linked to the commodities and precious metal markets in particular. We like, in Canada in particularly, that they have a good fiscal discipline; they do not have an enormous trade deficit. While the global economy may slow down, central banks around the world may try to push for growth and commodities. Rather than investing in the commodities, we invest in the currencies that may benefit from that.
The only commodity we have in the Hard Currency Fund is a small allocation to gold. It has been hovering around 8%.
Derivative exposure in the fund is kept to a minimum, but using the gold futures helps us with our cash management. We are allowed to use up to 5% in gold futures exposure and traditionally have stayed significantly under 2.5%.
We do not have the Japanese Yen in our Hard Currency Fund; however, we do have the Japanese Yen in our Asian Currency Fund. Although we do believe that there is a speck of this potential in the Japanese Yen, we do not think that the Bank of Japan pursues what we call a sound monetary policy. There is too much political influence at the Bank of Japan and the Bank of Japan may engage in an irrational move if their domestic economy suffers too much from a strong Yen.
Q: In the Asian Currency Fund, how many currencies do you have?
A : We have about 10 currencies in the Asian Currency Fund. We do have traditionally the biggest exposure to the Chinese Yuan with over 40% and other significant currencies traditionally have been the Singapore dollar, the Japanese Yen, the Korean Won, and we do also have the Hong Kong Dollar. The Hong Kong dollar is pegged to the U.S. Dollar. Those allocations may change in the future. We have a significant allocation to Taiwan as well. We also have allocations to Thailand, Philippines, Malaysia, Indonesia, and India.
Q: What is your buy/sell discipline?
A : We try not to engage in tactical trading, which means we tend not to make short-term adjustments. We try to have a managed basket and have a steady hand with that basket. When we have inflows, we buy a basket of hard currencies or of Asian currencies, then, we tend to hold those currencies and make small adjustments based on our interpretation of our monetary policy vault, partially just a rebalancing based on inflows or outflows that we may experience. Once we have the currency allocation, we buy short-term money market instruments and those we buy mostly based on market availability.
Rather than buying a mortgage-backed security that may have a higher yield, we have tended to buy a government security not linked to the mortgage sector even if the odds are high that the mortgaged security may perform. This is because it is not a risk that we seek. Our investors are more interested in the currency exposure. The yields that one may receive from these securities are a bonus. We pass that net on our expenses. We would prefer to sacrifice yield and not expose our investors to the credit instruments that may be under stress.
Q: What is your risk control process?
A : The main risk our funds have is the currency risk. Our investors specifically seek that risk. The investors buy our funds because they want the currency risk. We try to give it unleveraged and avoid excessive risk taking. Other risks that we have are interest and credit risks and we try to minimize those.
Interest risks are the risks that a fund may lose in value if interest rates go up. By staying on the money market end with an extremely short maturity of 90 days or less in our Hard Currency Fund - in our Asian Currency Fund, we may go up to a year - we try to minimize our negative implications from potentially high interest rates. The typical international bond fund has its maturity measured in years whereas we measure ours in days.
Credit risk is a risk of the potential fold of a security in which we invest. We try to address that by focusing on top tier rated securities in the current environment where markets have been under stress. We have focused particularly on government securities and, while we are a non-diversified fund at the Hard Currency Fund, we still have some diversification requirements. We are not able to put 100% of our money into a German treasury bill. We have to spread those investments around and we cannot buy all treasury bills in all the countries. We have to buy other securities as well. We try to focus on a basket of reasonably safe securities.