One of the toughest investing questions for mid-year is whether or not to hedge your exposure to the U.S. market.
Though it has weakened a bit in May, the Canadian dollar has been strong on the whole in 2016. This rebound from a four-year decline has brought disappointing results for investors who hold unhedged U.S. stocks and funds. Is it time to add some hedged U.S. content to protect against further appreciation in the U.S. dollar? An expert voice on this matter leans toward no.
"As a Canadian investor, I have generally preferred unhedged exposure to U.S. equities," Bernard Lahey, former chief investment officer for the Hydro Quebec pension fund and currency manager at the Caisse de dépôt, said in an e-mail response to this column I wrote on currency moves and your portfolio. Here are some key reasons he supplied:
1.) Unhedged exposure is a form of protection against financial catastrophe: When markets are in an uproar, money flows to the U.S. dollar. This provides a lift to unhedged U.S. assets. "…if you are looking for some type of insurance against catastrophic events, stay unhedged," Lahey writes.
2.) Surprising as it is, unhedged exposure to the U.S. market is less volatile than hedged exposure: As U.S. stocks rise, the loonie tends to appreciate and thereby reduce returns on unhedged U.S. exposure. Falling stocks can help send the Canadian dollar lower, thus cushioning losses in the U.S. stock market.
3.) Less volatility has its benefits: There's potential for a steadier, more comfortable investing experience, and also higher long-run returns.
4.) Currency exposure is more complex than you think: A significant portion of the Canadian stock market reflects exposure to the U.S. dollar. Also, while U.S. stocks are denominated in U.S. dollars, roughly half of profits come from international markets.
I've suggested investors hold both hedged and unhedged exposure to U.S. stocks, but for behavioural reasons and not for optimum returns. The idea is that you're unlikely to unwind a sensibly designed portfolio's U.S. holdings if you know that roughly half your position is in synch with the Canadian dollar.
Mr. Lahey's veteran take on this question: "Leave your stock exposure unhedged. If you want to trade currencies, open up an account."