recent steady decline of the U.S. dollar against the euro and other currencies has created a tailwind, lifting returns of overseas investments for U.S. investors. Currency opportunities are tied closely to variations in international interest rates. For example, if interest rates rise to 4% in Europe while staying at 2% in the U.S., the value of the euro relative to the dollar should increase proportionately. Although reality doesn’t always conform to theory, interest rates do create the potential for short-term gains through currency investment.

For an investor who hopes to capture the long-term value of an investment regardless of currency fluctuations, it may make sense to remove those fluctuations from the equation—for example, if a U.S. investor has achieved her goal of putting 25% of her overall portfolio in overseas securities. She’s comfortable with the long-term prospects of her choices, but is concerned that a rise in the dollar will eliminate some of her overseas gains. Rather than sell those carefully chosen investments, she can protect herself by purchasing a currency basket—an investment product containing a variety of foreign currencies—that takes a long position on the dollar compared with the currencies of each country in which she invests. If the dollar rises, her investment in the
basket appreciates, offsetting any currency losses her other international investments might experience.

Another way to add currencies to the equation more strategically is through a structured investment such as a quanto, a derivative in which the underlying investment is executed in one currency—euros, for instance—but paid out in dollars. The exchange rate is determined in advance to remove exchange-rate risks from the investment.