Dollar doldrums turn eyes overseas

SAN FRANCISCO — Whether politically motivated or profit-driven, investors have been paying more attention to overseas opportunities since the Nov. 2 re-election of President Bush.

Regardless of feelings about the direction of the country in the next four years, the direction of the dollar is causing many to examine foreign strategies. And the lifting of the federal debt ceiling in early November by $800 billion has only sharpened the focus.

"The Bush government isn't terribly concerned about budget deficits in the short and long term," said Michael Kitces, a financial planner in Columbia, Md. "That could result in higher interest rates, possible inflation and a weaker dollar."

The currency trend surfaced as soon as the Republican presidential victory was confirmed.

Kitces described the phenomenon as "shorting the dollar." When investors believe American bucks hit a nadir, people will likely buy the currency while selling out of foreign positions.

But for now, "I would look to having cash invested in many countries," Kitces said. "If you had to pick one place, try the euro or investments in other stable countries."

Other timely strategies include mutual funds that hold assets in foreign denominations, plus exchange-traded funds (ETFs) representing non-U.S. currencies and companies — Barclays' iShares dominates this type of ETF business.

Among those offerings: the S&P Europe 350 Index Fund (IEV), MSCI EMU Index Fund (EZU), S&P/TOPIX 150 Index Fund (ITF) and MSCI Pacific ex-Japan Index Fund (EPP).

Mutual funds invested in nondollar-denominated securities (that are not currency hedged) include: Causeway International Value Fund (CIVVX), Dodge & Cox International Stock (DODFX), Vanguard International Explorer (VINEX) and Fidelity Diversified International Fund (FDIVX).

One caveat: Watch out for mutual funds designed to hedge currencies against one another, because they will not profit from a declining dollar. Read through the prospectuses to determine the portfolio managers' strategies.

A bet against the dollar

Meanwhile, yet another approach looks at individual stocks outside of the United States.

"Investing in international equities right now is a bet against the dollar rather than a bet on stronger foreign countries and companies," said Dean Harman, a financial planner in Woodlands, Texas. "It might even make more sense to invest in U.S. multinationals."

Many such companies can be found within ETFs based on the Standard & Poor's 500 and other major U.S. indexes. Global fixed-income mutual funds and ETFs provide yet another offshore opportunity with more diversification than individual bonds in foreign countries.

However, "U.S. fixed income is a better place to be than foreign ones, because analysts are expecting the yields to go up," Harman said.

Harman periodically fields questions from high-net-worth clients about much riskier offshore strategies: transferring assets to locales considered to be tax havens.

Yes, that is tax evasion in the IRS' eyes, unless the investor reports offshore income and pays U.S. taxes accordingly.

Forming a foreign corporation legally shields money from taxation in the United States, although the federal government still expects such entities to pay up for any income earned in America.

However, moving the money back into the United States involves a lot of red tape even in the best-case scenario. The IRS levies taxes on repatriated funds, and often audits them, as well. An audit might lead to an investigation and possibly charges of tax fraud if the tax agency gathers sufficient proof — such fact-finding has gotten sophisticated in recent years.

"Anti-terror, anti-drug and anti-money-laundering laws enacted over the past 20 years, combined with the millions of dollars spent by the government on improved technology, make it a lot easier to catch people trying to evade taxes," explained Tony Santos, a partner at the international law firm Rojas Santos Stokes & Garcia in Miami.

All of these factors together create a "myriad number of ways that someone could get caught," Santos said.

Not a foolproof system

But not everyone believes that the system is sufficiently foolproof.

"Generally, when you have money in other countries, it's hard for the IRS to find out how much you're earning outside the U.S.," Kitces said. "But the larger the amount of money involved, the harder it becomes to explain if it 'disappears' from your next tax return."

The IRS expects U.S. citizens to pay for capital gains on foreign investments; to avoid the likelihood of double taxation, so-called tax treaties exist with individual countries.

Since each nation has specified different terms, sorting out taxes can be extremely complicated when multiple countries are involved.

While waiting for tax refunds from foreign countries can certainly add some risk into the bargain, it's only the tip of the iceberg: Investing in any foreign country is risky by definition, Santos pointed out.

Not only do laws vary from one jurisdiction to the next, but also the respective governments hold U.S. investors to a higher standard for compliance.

"Most foreign nations know the U.S. is good for its money, so they expect us to be better at compliance and paying taxes than their own residents may be," Santos said.

However, less-developed countries tend to have fewer regulations, which may leave investors without recourse should fraud arise. Sources say newer jurisdictions may lack a central bank infrastructure and may be run by businesspeople rather than regulators.