By SARAH MORGAN
Japanese automaker Toyota> has long been a consensus favorite of international investors. But whether they like the company for its pole position in the fuel economy race or for its access to the rising Yen is increasingly a matter for debate. When it comes to currency exposure these days, even the experts can't agree.
Most international stock funds have traditionally welcomed exposure to foreign currencies, especially when the dollar is weak, as it's been. But thanks to the recent wild swings of many currencies, some high-profile funds including the $46 billion Dodge & Cox International Stock fund
At the same time, some funds that have historically avoided currency exposure are going the other way. For example, the $2.2 billion Longleaf Partners International fund
So who's right? So-called selective hedgers say the currency markets are simply too volatile to sit on the sidelines. For example, the Dodge & Cox International Fund began hedging following the dollar's nosedive in 2008 in order to protect the returns of its foreign-denominated assets when the greenback came back, says Wolper. The bet paid off: As the dollar climbed in late 2008 and early 2009, the fund jumped from 4 percentage points behind the average large-cap international value fund in 2008 to 17 percentage points ahead in 2009, with a 47% return. Investors are likely to continue seeing more funds employing selective hedging "because currencies have been so volatile, and that has such an effect on returns," says Wolper.
Unhedged funds counter by saying exposure to other currencies is one of the best reasons to own international stocks in the first place, especially considering the long-term slide of the dollar. Consider: Developed international stocks gained 3.2% in their local currencies through the first week of March, but in dollars, American investors would have earned 5.1%, because the buck has been falling, according to a report by Alec Young, an international equity strategist with Standard & Poor's Equity Research.
Worse yet, it can be difficult to suss out a fund's hedging strategy. It's pretty common for international funds to retain the right to hedge in their prospectuses whether they historically have or not, says Jeff Tjornehoj, a senior research analyst at Lipper. "It remains murky for investors to understand who's hedging and to what degree," he says. "A lot of funds look at their hedging strategy as proprietary." One rule of thumb: Index funds typically don't hedge, because index returns aren't adjusted for currency fluctuations, says Theresa Hamacher, the president of the National Investment Company Service Association. Also, most Fidelity and Vanguard funds don't hedge, Wolper says.
Given the choice, most advisers and experts recommend seeking out un-hedged funds, because hedging typically drives up the cost of your fund and only pays off when the dollar is strengthening, says Young. "The costs are permanent, but the benefits are sporadic," he says. Two funds worth considering that have outpaced their peers over the past five years: The Vanguard International Value Investor fund,