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the loonie

Talk about a divergence of opinions: Italy's UniCredit bank believes the Canadian dollar will be worth $1.05 (U.S.) by the end of 2012, and London-based Redtower Asset Management forecasts an 81-cent loonie.

Of 39 financial firms polled by Bloomberg, the average forecast was $1.00 – parity.

What do you think? It's important that investors ask themselves that question, financial experts say, because currency fluctuations can have a huge impact on returns.

"Absolutely [currency]needs to be factored in," says Camilla Sutton, chief currency strategist with Scotia Capital Inc.

That's especially true when you're thinking about investing internationally. She cites the example of a person who wants to invest in the U.S. S&P 500. There is an equity side to that investment, which the investor "has probably thought a lot about." But there is also, less obviously, a currency side, "which I'm not sure is always thought about."

Both the S&P 500 index and the Canadian dollar are up about 2 per cent this year to date, Ms. Sutton says. So if you made that investment a year ago, "you're pretty much flat at this point."

Huge differences in valuation over the years – the loonie is trading near parity now but about a decade ago it was worth 63 cents – mean Canadians with investments in the United States could be particularly hard hit, says Philip Lee, senior fund analyst with Morningstar Research Inc. "Certainly, year after year, people were ignoring currencies, ignoring that effect, and you realize, 'Wait a second, half my returns were wiped out because of the Canadian dollar appreciating.'"

But it works both ways. The average forecast of the 39 financial firms may be parity for year's end, but most currency watchers predict the loonie will eventually depreciate.

As Gareth Watson says, "Eventually that currency is going to come down."

Mr. Watson is vice-president of investment management and research at Richardson GMP Ltd., a wealth-management firm. Currency is "kind of an add-on return," he says, and investors who plan to buy and hold an equity for 20 years should base that decision on the fundamentals of the company. "Who knows where the currency will be then?" he says.

Ms. Sutton points out that investors who don't have a view on where currencies are headed can buy investments that are fully hedged. Most mutual funds now have that option, she says. So, too, do many exchange-traded funds.

Mr. Lee says that Morningstar examines whether fund managers hedge for currencies or factor currencies in investment decisions.

Investors also can use currency as a way to diversify, says Paul Masson of the University of Toronto's Rotman School of Management. "It is important to diversify one's risks, and holding a basket of securities in domestic and foreign currencies may be a way of doing so."

Currencies also should influence asset allocation, says Paul Taylor, chief investment officer of BMO Harris Private Banking.

"I think there's probably at least as good value in the U.S. equity market as in the Canadian equity market at this juncture, but I'm not convinced that I want to take on that additional U.S. dollar exposure and volatility," he says.

Mr. Taylor predicts that in 2012, the U.S. dollar will weaken compared with the loonie, but modestly so. "We're not going to have a 10-per-cent swing in the Canadian-U.S dollar relationship," he says.

But he does have concerns: Will the U.S. presidential election end with a hung Congress and "another four years of potentially dysfunctional government?" On the Canadian side, how will the global economic backdrop affect commodity prices, an important factor for the value of the dollar and equity markets?

Ms. Sutton says Scotia Capital sees the Canadian dollar ending 2012 at $1.02, "a stronger Canadian dollar than we have now, a stronger dollar than we had at the end of 2011."

The reasons? International investors are looking to place their money in countries that are triple-A-rated sovereign, and that's a narrowing field, she says. Commodity prices will do well, she says, and the relative fundamentals of Canada "still shine."

Mr. Watson sees the global and U.S. economy both doing better, which will be positive for the Canadian dollar. But it's not as sure a thing for the U.S. dollar, he says: A rosier global economy may mean that investors worldwide who put their money into U.S. treasuries during the recession may decide to reduce those holdings and repatriate some of the money.

Loonie trajectory

Ten financial institutions and their forecasts for the Canadian dollar at the end of 2012:

UniCredit – $1.05 (U.S.)

Wells Fargo – $1.04

Scotia Capital – $1.02

BMO Nesbitt Burns Inc. – $1.00

CIBC – $1.00

Morgan Stanley – 97 cents

Credit Suisse Group – 96 cents

Citigroup – 93 cents

Saxo Bank – 87 cents

Redtower – 81 cents

Source: Bloomberg