How Does a Strong Dollar Affect International Mutual Funds?

When a mutual fund buys stocks or bonds on a foreign exchange, it must use the local currency -- pounds in England, euros in Frankfurt and Paris, yen in Japan and pesos in Mexico City. The fund manager converts the U.S. dollars that shareholders have invested in the fund into the new currency at the going rate, which fluctuates by the minute while the currency markets are open (which is 24 hours a day, Sunday evening through Friday afternoon).

When the dollar rises, local currencies become cheaper, as do the securities denominated in those currencies. That means an international fund's holdings will lose value when the fund fixes the daily net asset value or NAV: the total assets in the fund divided by the number of outstanding shares. With everything else remaining equal, U.S. investors in international funds loses out when the dollar rises.

The foreign stocks and bonds held in the portfolio of your international fund gains value when the dollar falls. This is true whether the stocks are traded on a foreign exchange or the fund is holding American Depository Receipts on a U.S. exchange. The ADRs represent shares of foreign companies; although they are bought and sold in dollars, they respond to public supply and demand, and the market generally reacts favorably when their local currencies are rising.

Fluctuating exchange rates have long-term effects as well. When the dollar is trending down over a period of months, foreign goods become more expensive and companies selling to the U.S. market sees competition rise and sales drop off. When the dollar rises, foreign goods get cheaper, and foreign companies enjoy an advantage over domestic producers. An international fund will explain its investment and geographical focus in a prospectus; smart fund-buyers will study and research this information before committing their hard-earned dollars.