Dollar falling. Invest here.

It has not been a good year for the US dollar. In April, it hit a nearly 3-1/2-year low against the Canadian dollar and a more-than-65-year low against the Australian dollar. It stood at a 15-month low in relation to the euro after sliding more than 20 percent since last June. On May 3, it fell to an all-time low against the Swiss franc.

All of this has left some US investors wondering:

Is there a way to capitalize on the sliding US dollar – and protect the value of a dollar-denominated portfolio?

Much depends on the time horizon. In the short term, quite a few analysts expect the greenback to start strengthening, at least among major currencies. In the longer term, many analysts expect the value of the dollar to fall against some emerging market currencies. So, if you're a dollar bear, consider shifting assets into stock or bond mutual funds that invest overseas. Even stocks of US multinationals offer some opportunity, since they earn profits in many different countries.

The more direct way to profit from a sliding dollar is through currency funds. Most of these mutual funds and exchange-traded funds in the United States essentially bet on the value of the dollar falling, says Jeff Tjornehoj, senior research analyst at Denver-based Lipper, a fund-information firm. Currency mutual funds typically invest in various foreign currencies and currencylike issues, versus ETFs that typically focus on a single foreign currency against the dollar.

Strength of currency funds

Currency funds have been gaining in popularity, at least in part, amid a rise in negative views on the dollar. In this year's first quarter, the category drew in some $479 million of net assets, according to Morningstar Inc., an investment research company based in Chicago. That's in sharp contrast to 2010, when some $275 million flowed out of currency funds. As of March 31, 2011, the funds had $7.9 billion in assets, according to Morningstar.

One fan of currency funds – specifically those focused on emerging-markets currencies – is Jerome Booth, research head of Ashmore Investment Management, an investment-research firm based in London. Of his own personal assets, "emerging markets currency investments are my second-largest holding," he says. "It's important for the US economy that exports do well. And for that to happen, the US dollar needs to decline further" – especially against the currencies of faster-growing economies.

This past December, Ashmore launched a US mutual fund for investing in emer­ging markets currencies – initially for institutional investors and now for average (or retail) investors as well. This month, Prudential Investments in Newark, N.J., launched the Prudential Emerging Markets Debt Local Currency Fund, its first such fund for US retail investors.

"We think there is tremendous opportunity for investors … who are recognizing that there are higher returns available in emerging markets, and in particular, emerging market currencies," says Cathy Hepworth, a senior portfolio manager for Prudential's fund. "People are aware of the weak dollar and, given what's been happening in the US, I think that trend will continue."

But don't look for currency funds in many 401(k) plans: Very few of them now exist in defined contribution retirement plans, says Micah Fannin, senior consultant with Mercer Investment Consulting Inc. in Chicago. Moreover, performances haven't been dazzling, at least among some currency mutual funds. They averaged a 0.84 percent advance in this year's first quarter, but lost a slight 0.02 percent in 2010 after losses of 1.73 percent in 2009 and 2.38 percent in 2008, according to Morningstar. By comparison, currency ETFs gained an average 2.13 percent in this year's first quarter and rose 5.46 percent in 2010 and 8.91 percent in 2009, but fell 6.64 percent in 2008.

"The average actively managed [currency fund] has not done that well," says Nadia Papagiannis, a Morningstar analyst. "As with any other category, if you're looking for an active currency manager, you've got to make sure they are good ones. Otherwise, ETFs would provide a less costly way to invest in currencies."

Small window of opportunity

The short-term outlook for currency funds is not bright. Some analysts foresee a change in policies that affect the value of the US dollar – at least against major currencies. By late June, for instance, the Federal Reserve is widely expected to end its program of buying Treasury securities to help maintain its loose monetary policy. From there, some analysts think, the Fed might start hinting at higher US interest rates, which tends to boost the dollar.

The dollar's slide could end this summer – and US interest rates begin to rise later this year, says Joseph Trev­isani, chief market analyst for FX Solutions, a foreign-exchange broker based in Saddle River, N.J. That means currency investors may have only six months of opportunity to play the falling dollar.

Even if the dollar rallies against developed countries' currencies, it's unlikely to do so against emerging market currencies, says a spokesman for Ashmore Investment. "Economic growth in emerging markets is likely to continue outpacing that in the developed world. That will keep inflation and interest rates higher in emerging markets and support their currencies. This is a favorable scenario for our emerging markets currency fund."