essays pieces of the puzzle
Monday, November 7th, 2011
foreign affairs

In my posting on how “a very delicious direction” in asset prices can alter the investment process, I said that “one area that needs a great deal of scrutiny right now is the effect of currency movements on results for U.S.-based investors.”

Here’s an example.  In the top panel are the three largest foreign bond funds in the U.S., according to Morningstar.

First, some nomenclature.  “Foreign” or “international” funds are comprised of non-U.S. assets, whereas “global” funds include the U.S.  Keeping the terminology straight, however, is tricky business sometimes.  The name of TPINX is the Templeton Global Bond Fund, even though it doesn’t fit that definition as traditionally used.  (T. Rowe Price International, RPIBX, and Oppenheimer International, OIBAX, are the others shown.)  TPINX, managed by Franklin Resources, is the goliath of the category, with five times the assets of each of the other two.

The lower panels show the dollar index (DXY) and the yield on the U.S. ten-year note.  Both are shown with inverted scales, so that their movements are directionally similar to the total return that they should produce.  (Of course, each is a rough measure for this purpose.  There are many ways to look at the dollar’s movements and the U.S. note as a global proxy is not foolproof.)

There are a number of points of note in just this short chart.  It’s incredible how closely intertwined RPIBX and OIBAX were during the first few months, and how much TPINX lagged at that time.  But when the dollar rallied, TPINX held steady while the others gave their advantage back.  Now look at September of this year.  A complete change, with TPINX taking the brunt of the currency move.

As a result, there is a lot of hand-wringing about the fund (P&I:  “Franklin giant hit by currency bets”) and the huge asset flows into it have started to reverse, contributing to a significant decline in Franklin Resources stock (BEN), the flip side of the action of just three months earlier.

The ripple effects of this will be worth watching.  Investors have been having lots of foreign affairs; if they come undone, there will be messiness.  (Chart:  Bloomberg terminal.)