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March 24, 2009

Why is the dollar getting stronger?

At Venture Intelligence's Annual Private Equity conference in February, a leading PE fund manager remarked how investors were now forced to pay more heed to currency movements than their portfolio companies' operational performance. The US dollar's dramatic appreciation in recent months has indeed astounded many.

In an article for the Economic Times, Sunil Kewalramani, provides some reasons why the currency of the country in the middle of the global financial mess - and, according to several predictions, in the midst of a multi-year slowdown - is actually appreciating.
A number of analysts had predicted the continued demise of the US dollar, thanks to the financial-sector bailout and weakening economy but its sharp upside has surprised many. The dollar’s recent climb is part of a massive reversal of long-standing investing trends (due to the global economic slowdown) such as buying emerging-market stocks or wagering on rising commodity prices.

...Aside from the actions of global reserve managers, activity from US mutual funds shows an unwillingness to increase their allocations to
foreign markets. This matters because US fund managers hold $30,000 billion of domestic and foreign securities, compared with the estimated $7,000 billion of foreign currency reserves managed by the world’s central banks.

Having increased their share of overseas assets from about 12.5% at the start of the decade to a high of 26% last summer, risk averse US funds reduced that share to 23%, where it has remained so far in 2009. I see further reductions in the proportion of their portfolios held in overseas markets and the subsequent repatriation of capital will help the US to continue to fund its current account deficit and thus support the dollar this year.

Besides, long-term portfolio allocation data for all US investors shows global shocks historically have caused US investors to steer away from overseas markets for several years. This time risk-averse American fund managers are unlikely to behave any differently in their response to the global economic slump.

Arun Natarajan is the Founder & CEO of Venture Intelligence, the leading provider of information and networking services to the private equity and venture capital ecosystem in India. View free samples of Venture Intelligence newsletters and reports. Email the author at arun@ventureintelligence.in