For individual investors, ‘setting up currency hedging at a low cost in an efficient way is not easy to do,’ says Colin Stewart of Toronto-based JC Clark Ltd.
Judging by the latest batch of forecasts from currency experts, the Canadian dollar is definitely headed in one of three directions: up, down or sideways.
If the experts can't see eye-to-eye on the loonie, there's little hope for the average investor to get it right. That's why some investment advisors suggest trying to blunt the impact of currency fluctuations and focus on investing for the long-term.
"Our job is to be investment managers and select securities, invest in companies and make decisions on which equities are good to be in. We're not in the business of speculating on currencies," says Colin Stewart, chief executive officer and portfolio manager at Toronto-based JC Clark Ltd.
JC Clark offers an array of funds with investment strategies tailored to individual clients. The strategies differ but generally defer to neutralizing the impact of Canadian dollar fluctuations against the U.S. dollar, which is the global standard. "We typically hedge 100 per cent of the currency risk," says Mr. Stewart.
Exceptions are made for clients who spend a good part of their time and money in the United States, he says, or when fluctuations between the Canadian and U.S. dollars go too far in either direction. "When we have a very strong view on the currency we will take some kind of direct exposure," he says.
In the short term, Mr. Stewart believes the Canadian dollar is due for a decline after a surprise interest-rate hike by the Bank of Canada pushed it to new highs over the summer.
At the same time, he expects further rate hikes by the U.S. Federal Reserve will strengthen the U.S. dollar. "We feel pretty strongly that we want to have some exposure to U.S. dollars today," he says.
Attempting to hedge against, or benefit from, currency fluctuations is no easy task. JC Clark utilizes large pools of capital in the complicated derivatives market. "We do it on behalf of our clients in one pooled structure and we can do it at a low cost very efficiently," says Mr. Stewart. "If you're an individual investor with one account, setting up currency hedging at a low cost in an efficient way is not easy to do."
Cole Kachur, senior wealth advisor at Scotia Wealth Management in Saskatoon, agrees that hedging currencies can be difficult for the average investor. He says the challenge is compounded because most investors don't fully appreciate how currency fluctuations can affect their portfolios.
"It's something I don't think a lot of advisors or clients pay enough attention to, the currency aspect of their portfolios and the way that it can have a direct impact not only on volatility but potential returns," he says. "In a lot of cases, currencies are the most volatile commodity out there."
The benchmark index for U.S. equities – the S&P 500 – provides a good example of how currencies can have a stealth impact on performance for Canadian investors.
If you invested in the S&P 500 index in U.S. dollars (unhedged) on Jan. 1 of this year, your return would have been 15.4 per cent by mid-November. If you invested in the S&P 500 index hedged in Canadians dollars over the same period, your return would be 9.2 per cent. The hedged return is lower because the Canadian dollar rose 5.6 per cent, to 79 cents from 74 cents to the U.S. dollar over the same period.
As the loonie increased in value to the U.S. dollar, the value of U.S.-dollar-denominated equities decreased in Canadian dollars.
"If you look at the underlying results, it wasn't the actual return being generated from the companies that were invested in, but more the currency that was a big driver," says Mr. Kachur.
To hedge against currency volatility, Mr. Kachur could use hedged exchange-traded funds (ETFs), such as those that track the S&P 500. Many mutual fund providers offer hedged versions of their funds. Hedged funds come at a cost to the investor in the form of higher annual fees, but Mr. Kachur says paying extra for reliable returns with limited risk is often worth sacrificing some of the return.
"I want to own the companies, and I'm comfortable paying a hedge fee to get that protection. I also understand that it can cost in terms of profit," he says.
Canadian investors wanting indirect exposure to U.S. dollars at no extra cost can buy Canadian companies that generate revenue in U.S. dollars, such as resource producers. They can also buy U.S. stocks in the lucrative technology and health-care sectors in U.S. dollars through their registered retirement savings plans (RRSPs).
"A U.S.-dollar RRSP account is a good way to avoid falling into the trap of having the majority of your money invested on a home bias," he says.
Canadians can also buy and sell U.S. dollar-denominated investments in their tax-free savings accounts (TFSAs), but Mr. Kachur warns investors they could face tax consequences for U.S. dividends. "In tax-free savings accounts you have to be cognizant because the rules regarding dividends and distributions in some U.S. companies are different than if you just owned Canadian-domiciled funds."
While currency speculation takes a back seat to investing for Mr. Kachur, he does have a breaking point if the Canadian dollar rises too quickly.
"I'm not a currency analyst, but if we can stay somewhere around the 80-cent mark, that probably works out for most parties involved," he says. "If the dollar goes up to 90 cents I would probably look at going the other direction and go unhedged and try to pick up some return potential."