By JASON ZWEIG
How can you lower your portfolio's risk in a world of rolling government-debt crises? Start by taking a deep breath. Then, see if you need to do some tinkering but not too much.
With Europe in turmoil, investors are so eager for a "safe haven" that this week they were willing to accept a return of only 0.01% a month to hold Treasury bills. Such yields on short-term Treasurys are barely a sliver above their all-time lows, even as Uncle Sam's own debts may be teetering on the brink of default.
Fears are rampant that the U.S. may lose its triple-A credit rating, that the economy will stay stagnant, that inflation will eventually surge and that the dollar will wither. Lately, U.S. Treasurys and the dollar have rallied mainly because other nations are in even more of a mess.
Amid such uncertainty, you can't reduce one set of risks without raising others. If, for instance, you buy gold, you lower the risk that a collapsing dollar will crush your wealth. But you incur other hazards by paying all-time-high prices for an asset that generates no investment income, lacks intrinsic value and has a weak record of combating inflation. Other hedges carry other risks and trade-offs.
Thus, making a sharp course correction may cut your exposure to the U.S. dollar or inflation but if today's fears don't materialize, or the future turns out to be full of its customary allotment of surprises, then your sudden shifts may turn out to hurt you. So moderation is the key.
Normally, explains Laurence Siegel, research director at the Research Foundation of CFA Institute, U.S. investors should tilt toward holding assets denominated in dollars, since their future spending also will be dollar-based. "However," Mr. Siegel says, "today's extraordinarily low yields on dollar assets drag the solution the other way toward international diversification." If, for instance, you normally keep 20% in non-U.S. stocks, you might begin raising that to 25%.
Some heavy-hitting investors are beginning to move in that direction, even in their own portfolios. "Going into the crisis, all my [personal] safe money was in U.S. Treasurys," says Howard Marks, chairman of Oaktree Capital Management in Los Angeles, which manages more than $80 billion. "Now, it's in the debt of a variety of countries, on the assumption that some of their currencies may well gain versus the dollar."
Likewise, Todd Petzel, chief investment officer at Offit Capital Advisors in New York, says his firm is spreading its clients' assets into short-term securities issued by non-U.S. governments. Mr. Petzel favors countries with low levels of debt and a wealth of natural resources, such as Australia, Brazil and Canada.
Relatively new mutual funds make it easier for small investors to spread bets again, in moderation.
Emerging Currency (CEW: 23.09, -0.09, -0.39%) are exchange-traded funds offering exposure to foreign currencies that, so far at least, have been relatively unscathed by the government-debt crisis. Commodity Currency provides exposure to money issued by Australia, Canada, Russia, New Zealand and four other countries that are major exporters of raw materials; Emerging Currency offers Brazil, China, India, Israel and eight other developing nations.
SPDR DB International Government Inflation-Protected Bond (WIP: 60.96, -0.22, -0.36%) and iShares International Inflation-Linked Bond (ITIP: 49.68, -0.13, -0.26%) are exchange-traded funds that hold the debt of more than a dozen governments world-wide, designed to keep pace with inflation in those countries. Such a fund could offer partial protection against a decline in purchasing power in the U.S.
The debt of developing countries is no longer cheap, but it still may offer some diversification. The iShares JPMorgan USD Emerging Markets Bond (EMB: 109.02, -0.04, -0.04%)ETF holds debt denominated in U.S. dollars, while Market Vectors Emerging Markets Local Currency Bond (EMLC: 27.19, -0.08, -0.29%) is a basket of government securities issued in Brazilian reis, Chilean pesos, Russian rubles and so on.
But remember: While many emerging-market nations may have better fiscal outlooks than the U.S., they still are risky. (If lending to Russia doesn't make you nervous, someone needs to check your pulse.) The currency funds may spread your overall portfolio risks, but they distribute income only once a year and aren't a substitute for cash.
"If the markets get scared again and there's another flight to quality," says Larry Swedroe, director of research at Buckingham Asset Management in St. Louis, "then the dollar will go up and kill your unhedged foreign bonds just when you most want them to keep you afloat."
If you do move any money in response to the debt crisis, move small amounts slowly. A future that seems this inevitable may not even happen precisely because it seems so obvious. As Mr. Marks asks: "Is the world less safe than it used to be? Or was it never as safe as we thought it was? Maybe the risks were higher before, when nobody was conscious of them."
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