Currency Impact on Portfolios

Over the last 5 months, the Canadian dollar has risen substantially versus the US dollar (an approximate 13% increase).  This is good news for shopping across the line, but bad news for the US dollar exposure within our portfolios.

Global investment opportunities complement your existing Canadian investments, pension entitlements or real estate, by providing a more well-rounded investment portfolio.  By diversifying your investments globally, there is potential to increase your portfolio’s growth potential while reducing risk.  Although the overall risk within your portfolio may be reduced, when you add foreign investments to a portfolio, there is currency risk (if the investment does not hedge this risk).   

For example, consider a Canadian mutual fund that holds US stocks. Investors buy the fund using Canadian dollars. The fund has to convert these Canadian dollars to US dollars in order to purchase US stocks. If the US dollar rises relative to the Canadian dollar, any exchange-rate gain will add to the fund’s total return. However, if the US dollar falls, any decline will reduce the fund’s total return. Even if all the fund’s underlying stocks were to remain unchanged in US dollar terms, the fund would still change in value due to the effects of currency fluctuations because it is priced in Canadian dollars.

What should I be doing?

Investors shouldn't make investment decisions based on expectations of future foreign currency movements. Here are four reasons why:

1. It is almost impossible to predict the timing of currency movements. 
   Predicting when a particular currency may rise or fall is a very difficult task. In fact, Allan Greenspan, former chairman of the U.S. Federal Reserve, once likened the probability of accurately forecasting short-term exchange rates to that of a coin toss.
2. The impact of currency movements tends to diminish over time. 
   While exchange rates fluctuate from year to year, the impact of currency on investment returns declines over time.
3. In a diversified portfolio, currency movements tend to even out.
    A well-diversified portfolio has exposure to many different currencies. For example, global mutual funds will typically hold securities from the U.S., Europe and Asia – all denominated in different currencies (e.g. U.S. dollar, euro and yen).  The interplay between baskets of currencies is sometimes referred to as a natural hedge.  In addition, some management teams actively hedge out currency risk within their portfolios.
4. There's little reward for betting on currency over the long term.
   Currencies can fluctuate more in value than the stock market. Over time, investors are simply not rewarded for currency fluctuations the same way they are rewarded in the stock market.