In These New Times

Bond fund has made money by betting against the dollar (APP.com)
BY SREE VIDYA • BHAKTAVATSALAM • BLOOMBERG NEWS SERVICE • JUNE 22, 2008

Axel Merk, the top-ranked world bond-fund manager thanks to his three-year bet against the U.S. dollar, said the currency’s weakness will persist for as long as a decade despite government efforts to prop it up.

The $355 million Merk Hard Currency Fund holds no assets pegged to the dollar, which declined to a record low in April as the Federal Reserve cut interest rates to prevent subprime-related losses from stalling the economy. That helped Merk’s fund climb 11 percent in the past three years, the most of 45 rivals tracked by Morningstar Inc. in Chicago. This year, it has climbed 5.1 percent, ranking second.

Treasury Secretary Henry Paulson said on June 9 he would never rule out intervening in currency markets to bolster the dollar. Federal Reserve Chairman Ben Bernanke followed up on June 10, saying that the risks of a substantial U.S. economic slide have abated, suggesting he may raise interest rates. Their comments spurred the dollar June 12 to the highest level in four months compared with a basket of six other currencies.

“The Fed has done some tough talk — that’s the cheapest policy tool they have,” Merk, 38, said in a June 11 interview from Palo Alto, Calif., home to his Merk Investments LLC. “But this is no short-term issue. It might get a cyclical bump, but the dollar will remain weak for about 10 years.”

The Merk fund, which opened in May 2005, has a three-year Sharpe ratio of 1.14, compared with the 0.03 Sharpe ratio for competing funds, according to data tracked by Morningstar. A higher Sharpe ratio means better risk-adjusted returns. The fund has Morningstar’s highest rating of five stars.

Recovery not sustainable

The Dollar Index, which measures the U.S. currency against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc, has rebounded 3.4 percent from its April 22 low as investors expect the Fed to start raising interest rates. Merk, known for his persistently negative views on the currency, said the Fed can’t raise interest rates if it wants to stimulate economic growth.

“We are in a global credit contraction, consumers are tapped out and banks are overextended,” he said. “We’re in no position to tighten.”

The Fed has cut interest rates to 2 percent from 5.25 percent since September to counter slumping home prices and to contain a liquidity crisis triggered by a sharp increase in subprime-mortgage defaults.

“A fund betting against the dollar has done quite well over the past few years,” Gregg Wolper, a senior fund analyst at Morningstar, said in an interview. “The difficulty is figuring out where things will go from here as many smart investors can get currencies wrong.”

Euro bonds

Merk has invested 39 percent of the fund’s assets in the euro, mainly in the form of government-backed bonds, as he believes the European Central Bank will successfully navigate its member nations through the credit crisis.

The euro reached a record high of $1.59 against the dollar in April. Merk expects the dollar to decline to $1.70 per euro by the end of 2008, as interest rates increase in Europe. ECB President Jean-Claude Trichet has said he may raise interest rates in July to curb inflation.

Merk has also put about 17 percent of the fund into Canadian treasuries, two-thirds of that in a bill that matures in August, because he said the country’s resource-driven economy will continue to grow. Commodities, such as oil and gold, account for about half of Canada’s exports.

Safety over yield

Canada’s dollar surged 17 percent in 2007 as the price of crude oil rose 57 percent.

Merk has 16 percent of the fund in lower-yielding Treasury bills in Switzerland, where the 2.75 percent key interest rate is the third-lowest among industrialized nations. Only the U.S. and Japan have lower interest rates.

“We often go for safety over yield,” Merk said. His second-largest holding, after the Canadian T-bill, is the SPDR Gold Trust, an exchange-traded gold fund.