One of the smartest investing moves over the past decade was to forgo currency hedging in your U.S. stock market holdings.
Now, it’s time to look at the case for reversing that approach and using funds that use hedging to block out the effect of Canada-U.S. currency fluctuations on returns.
In a recent note to clients, Richardson GMP took a look at the prospects for the Canadian dollar and concluded there’s reason to expect it to appreciate against its U.S. counterpart.
GMP Richardson says it made sense to go without hedging early this decade because the U.S. dollar was undervalued compared with many major currencies. “Today it is the opposite – nobody wants to hedge, and the U.S. dollar is now overvalued against most [major currencies],” the note says. “Based on this view, we believe investors should be more open to considering hedged investment strategies on a go-forward basis.”
You can most clearly see the benefit of holding unhedged U.S. investments in the return data for the five years to Sept. 30. The S&P 500 made an annual average 14.7 per cent in Canadian dollars, compared with 10.8 per cent in U.S. dollars. GMP Richardson points out that the U.S. dollar appreciated by an average annual 2.5 per cent over the past decade. “This boost, while not constant, has helped portfolio performance when translated back into Canadian dollars.”
Looking ahead, the GMP note says there are some reasons to be cautious about the Canadian dollar. If you think global economic growth is fading, then expect the U.S. dollar to outperform. On the other hand, the Canadian economy has been performing comparatively well and has exceeded expectations. GMP Richardson says that by one measure, the Canadian dollar is 10 per cent undervalued against the U.S. buck.
There’s a wide selection of U.S. equity exchange-traded funds and mutual funds that come in Canadian and U.S. dollar versions, generally with the same management expense ratio. If you’re putting new money into U.S. equity funds, consider a break from what worked over the past several years, which means buying funds that are hedged.