What to Do About Currency Fluctuations and Your Portfolio ? Best Answer: Nothing

The WSJ recently had a recent  article on investors and how they should react to currency fluctuations. The WSJ articles explains several ETFs that  hedge portfolios against a weakening dollar but their core conclusion hits the right note:

The dollar’s recent drop to a three-year low against other major currencies raises a natural question: How should investors in mutual funds and exchange-traded funds handle currency fluctuations?

There are many options, including funds that allow investors to speculate on currencies’ short-term direction. But analysts say investors are best off with a plain-vanilla approach—having some exposure to foreign currencies through international stock and bond funds and just leaving it at that.

Having worked in the currency markets over a dozen years I can testify that currency movements are impossible to forecast. One of my responsibilities was to routinely take media calls asking to "explain" the market moves of the day. Of course they weren't looking for an answer that the movements of the day were pretty much random and there always was some "reason" an economic release or central bank announcement somewhere in the world, movements in other commodity or financial markets. But all of those factors could have been used to "explain" movements in the opposite direction.

 I am reminded of a colleague who came home from work one day and her spouse asked her about the direction of the dollar. :"It's definitely going up,,she replied". Her husband responded" but two days ago you said it was definitely going down"..to which she answered"I changed my mind".

Given that currency movements are unpredictable and that unlike stocks in the long term: one cant count on the dollar to go up (or down) vs foreign currencies the best strategy is to take the positive diversification to both foreign economies and currencies by simply purchasing a foreign stock fund.
As for the currency diversification..you get that in both a stock and bond fund,

Note that I wrote foreign stock fund..not foreign stock and bond fund. A  foreign stock fund offers currency and stock exposure and the characteristics of stocks--long term unlimited upside and limited downside risk.

 A bond offers limited upside--interest rates cant fall below zero so capital gain on bonds is limited-- but potential losses are far higher since interest rates could move up in double digits creating double digit losses. As we know from duration 3 percent rate increase on an international bond fund with a 7 year duration is a 21% decline in price. So one would need a 21% favorable currency movement to make up for the price decline of the bond in local currency terms...a huge move even in the volatile world of currency markets.

Furthermore, the bond allocation of a portfolio is supposed to offer the stable anchor..international bonds add more stability. Emerging market bonds add even more risk.

Although making market calls is fraught with pitfalls it does seem to me that purchasing etf IAGG an aggregate bond etf which has a duration of 7.3 years and a yield of  .99% has a pretty more risk/return characteristics in terms of the prices of the bonds in the portfolio, As for currency risk..that can be taken through a foreign stock allocation.