Losing gracefully is part of being a good investor.
Some of us never got the memo. Submitted for evidence are the e-mails I'm getting from readers who are peeved about the impact of the rising dollar on their returns from U.S. stocks held directly or through exchange-traded funds and mutual funds.
They made a lot of money when the dollar was falling, but this year's reversal has cost them. They're annoyed about this turn of events and wondering who to blame. God help us when the housing market falls. People are going to self-combust.
In a lot of ways, investing is a grind these days. Interest rates are low, the stock markets are volatile and even more conservative things like preferred shares have been treacherous. But a lot of people have had a huge win lately. They owned U.S. stocks or funds that don't use currency hedging and thus got a lift as our dollar's decline over the past three years made those assets more valuable.
Hedging is where an exchange-traded fund or mutual fund means uses financial instruments called derivatives to dial out the distortions that currency moves cause to investment returns. It's a perfectly legit strategy to forgo hedging and let currency do its thing. Over 20-plus years, hedged and unhedged returns should be similar.
But in the short term, currency fluctuations can do dramatic things to your holdings outside Canada. Over the three years to March 31, the S&P 500 had a total return of 11.8 per cent annually (that's share price changes plus dividends) in U.S. dollars and 21.2 per cent in Canadian dollars. The MSCI Europe Australasia Far East (EAFE) index, a benchmark for investing outside North America, rose 6.9 per cent annually over the past three years in local currencies and 11.3 per cent in Canadian dollars.
Weakness in the Canadian market drove investors to pump a lot of money into U.S. stocks and funds in the past few years. It was a smart move and it paid off well if you didn't have any hedging in your portfolio.
Then came a surge in the Canadian dollar that began in January. Just as a sinking dollar adds to your returns from investments abroad, so does a strong currency undermine your results. For the first quarter of the year, the S&P 500 made 1.4 per cent in U.S. dollars and lost 5.6 per cent in Canadian currency.
The reversal in the dollar has unsettled investors and made them wonder where they, or their investment advisers, went wrong. The answer is that they've done nothing at all wrong. They're just experiencing one of the hard realities of investing, which is that every winning streak comes to an end.
It happened to energy stocks a couple of years ago, it happened to a particular type of preferred share called the rate reset and it's just happening now to returns from U.S. stocks. A strong candidate for a reversal to come at some point in the future is housing.
With respect to your unhedged U.S. stock market holdings, take the long view. You made great money in the past few years by being in a sweet spot. You're now giving up some of those gains, but you can lose gracefully because you're way ahead overall. Dwelling on how much you're down from the high-water mark just makes you crazy.
As an aside, adding some U.S. equity ETFs that use currency hedging would protect against more increases in the dollar (check out the U.S. equity fund instalment of my 2016 ETF Buyer's Guide). Think about a 50-50 mix of hedged and unhedged exposure to U.S. markets. This blend isn't optimized for performance – it's more about the comfort of always having half your portfolio in tune with what the Canadian dollar is doing.
Keeping some perspective about your investments applies doubly to your house. I argued in this column from January that deciding what to do with the family home is a top financial consideration for 2016. Long-time owners in big cities have made an awful lot of money over the years. They can afford to be graceful losers if prices fall.
Rob Carrick