Impact of
exchange rate changes
Our loonie
has found its wings this year – having soared to its highest gain ever in such
a short period of time. Since the beginning of this year, the Canadian dollar
has risen more than 17 percent against the U.S. dollar. The impact on
investment portfolios and how to deal with it can be confusing.
Among the
currencies of developed nations, only the Euro’s strength has even come close
to the loonie’s ascent so far this year – rising about 4 percent against the
Euro. But against the U.S. dollar, the Hong Kong dollar, the Japanese Yen, and
the British Pound, the Canadian dollar’s year-to-date gain is between 14 and 18
percent.
The value
of an asset will decrease if purchased in a currency that subsequently falls in
value – all else being equal. The value of an asset purchased will rise if
purchased in a currency whose value also rises.
More
specifically, Canadian investors who bought U.S. stocks at the beginning of
this year and held them would be staring at losses so far due to the
depreciation of the U.S. dollar versus the Canadian dollar.
U.S. and
international mutual funds sold in Canada are, at the end of each day,
converted to Canadian dollars. The assets of the fund aren’t physically
converted. Rather, the unit price is simply expressed in our home currency –
i.e. a mere accounting entry.
The bottom
line is that the U.S. stock market is up more than 10 percent this year, but
the fact that the U.S. dollar has fallen in value by more than 17 percent
against the Canadian dollar leaves many Canadian investors sitting on a loss of
7 to 8 percent.
A common
myth among investors is that they can buy some of their favourite U.S. stock
funds denominated in U.S. dollars (i.e. Dynamic Power American Growth US$).
However, that will not protect you since you’d still be sitting in the
weakening currency, if the current trend continues.
If you’re
going to spend that money in Canada anyway, it will have to be converted back
at some point. It might look better on paper but only because that currency
conversion accounting entry at the end of each day isn’t performed. But if you
end up having to convert it yourself, there really isn’t any difference.
Remember,
if you think the U.S. dollar will continue to weaken against the loonie (which
I happen to disagree with), you don’t want to be invested in U.S. dollars or
any investments that are denominated in the same.
Most fund
managers simply don’t take any action when it comes to currency – saying that
currency fluctuations even out over time. I agree with their decision but not
with their reasoning. Just look at the Yen or the Canadian dollar over twenty
year periods and you’ll see that things are often far from even.
However, so
few professionals can accurately and successfully forecast currency moves that
the decision to do nothing is likely a good one. Some may be critical of this
“non-action” policy but this is the same policy that allowed investors in
foreign funds to benefit from the 3-percentage point boost in annual
performance from our falling currency for many years.
There are a
few firms/funds you might consider if you want active currency management.
Talvest
Fund Management has an entire currency team. Since they believe that currencies
are a separate asset class, their job is to actively manage the currency in an
attempt to add some value to underlying fund performance by anticipating
exchange rate moves.
Mackenzie’s
Cundill Value fund tends to hedge (i.e. eliminate) foreign currency exposure so
that the fund’s performance reflects only the pure return of their stock picks.
Finally,
fully RSP eligible foreign index funds offer the opportunity to gain exposure
to foreign markets without the currency exposure. TD Bank, Altamira, and Royal
Bank all offer such funds. To read more about them, and how they work, see this
older
article.
Theories on
currency exchange rates suggest that a U.S./ Canadian dollar exchange rate
would be US$0.70 to US$0.73 per Canadian dollar. The fact that it’s gone beyond
that may be nothing more than a temporary overshoot. Economic theory tends to
hold over time, but there are significant interim periods that can cause us to
question its validity. And we’ve just capped nearly five years of shorter-term
deviation from the so-called equilibrium price.
I would not
recommend taking any action on currency at this point. The rise in the dollar
is substantially complete, in my opinion. Focus instead on investment issues
when structuring your portfolios. It’s time better spent.
A few weeks
ago, I wrote about the controversy of Canadian fund managers publicizing how
they vote
the shares they hold on behalf of unitholders. I highlighted Meritas as one
Canadian example that is progressive in this regard. I neglected to mention
others.
Ethical Funds discloses their voting
record online. In fact, they list their firm-wide record on one
page for all visitors to see. And while they don’t publicize their voting
record, Acuity Investment Management
does make the information available to requesting unitholders and financial
advisors.
Some may
notice that the few firms that disclose this information fall into the category
of socially responsible
investment (SRI) funds. However, not all SRI funds disclose their votes. These
firms should be duly recognized for raising the bar.
Dan Hallett, B.Comm., CFP, CFA is the Senior
Investment Analyst with Sterling
Mutuals Inc. He can be reached at dhallett@sterlingmutuals.com Sterling Mutuals Inc. is registered as a
mutual fund dealer in Ontario, British Columbia, Alberta, and Manitoba.