Some of the most regretful investors of the past year have to be the ones who invested in currency hedged U.S. and global equity ETFs and mutual funds.
Get this: The S&P 500 index was up 15.5 per cent for the year to the end of February in U.S. dollars and 30.3 per cent in Canadian dollars. Our falling dollar may have ruined your summer vacation plans and killed cross-border shopping, but it has done wonders for people investing outside Canada using unhedged funds. That goes for international markets, too. While the MSCI EAFE index in Canadian dollars underperformed a bit in the past year, it beat the index as measured in local international currencies 18.9 per cent to 16.8 per cent.
But that's old news, really. The issue all investors should be tackling now is not what hedging did for them in the past, but whether it will be a help or a hindrance in the future. My suggestion: Don't pick a side. Divide your U.S. and international exposure evenly between hedged and unhedged products.
There's no data to support this approach, just a behavioural argument. It's often said that currency ups and downs neutralize themselves over the long term, which argues for not bothering with hedging. But there will be times when hedged funds are a life saver. In the mid-2000s, our dollar soared enough to neutralize a lot of the gains to be had in investing in U.S. and global stocks. These were years when investors sold a lot of their U.S. holdings, a decision they no doubt regretted when the U.S. market began beating Canada a few years ago.
If you have half your U.S and international holdings hedged, you'll have partial protection if our dollar rallies back from its current lows. And if the dollar sinks further, maybe because oil falls further or the U.S. raises interest rates and we don't, then the unhedged half of your holdings will do well. Regardless of what happens with the dollar, you're covered and thus more likely to sick with the appropriate allocation of U.S. and international content.
The ETF industry is all over this strategy, by the way. Just about every new U.S. and international fund comes in both hedged and unhedged versions.