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Currency effects
Impact of exchange rate changes

Our loonie has found its wings this year - having soared to its highest gain ever in such a short period of time. Since the beginning of this year, the Canadian dollar has risen more than 17 percent against the U.S. dollar. The impact on investment portfolios and how to deal with it can be confusing.

Impact

Among the currencies of developed nations, only the Euro's strength has even come close to the loonie's ascent so far this year - rising about 4 percent against the Euro. But against the U.S. dollar, the Hong Kong dollar, the Japanese Yen, and the British Pound, the Canadian dollar's year-to-date gain is between 14 and 18 percent.

The value of an asset will decrease if purchased in a currency that subsequently falls in value - all else being equal. The value of an asset purchased will rise if purchased in a currency whose value also rises.

More specifically, Canadian investors who bought U.S. stocks at the beginning of this year and held them would be staring at losses so far due to the depreciation of the U.S. dollar versus the Canadian dollar.

U.S. and international mutual funds sold in Canada are, at the end of each day, converted to Canadian dollars. The assets of the fund aren't physically converted. Rather, the unit price is simply expressed in our home currency - i.e. a mere accounting entry.

The bottom line is that the U.S. stock market is up more than 10 percent this year, but the fact that the U.S. dollar has fallen in value by more than 17 percent against the Canadian dollar leaves many Canadian investors sitting on a loss of 7 to 8 percent.

Protection

A common myth among investors is that they can buy some of their favourite U.S. stock funds denominated in U.S. dollars (i.e. Dynamic Power American Growth US$). However, that will not protect you since you'd still be sitting in the weakening currency, if the current trend continues.

If you're going to spend that money in Canada anyway, it will have to be converted back at some point. It might look better on paper but only because that currency conversion accounting entry at the end of each day isn't performed. But if you end up having to convert it yourself, there really isn't any difference.

Remember, if you think the U.S. dollar will continue to weaken against the loonie (which I happen to disagree with), you don't want to be invested in U.S. dollars or any investments that are denominated in the same.

Mutual funds' currency policies

Most fund managers simply don't take any action when it comes to currency - saying that currency fluctuations even out over time. I agree with their decision but not with their reasoning. Just look at the Yen or the Canadian dollar over twenty year periods and you'll see that things are often far from even.

However, so few professionals can accurately and successfully forecast currency moves that the decision to do nothing is likely a good one. Some may be critical of this "non-action" policy but this is the same policy that allowed investors in foreign funds to benefit from the 3-percentage point boost in annual performance from our falling currency for many years.

There are a few firms/funds you might consider if you want active currency management.

Talvest Fund Management has an entire currency team. Since they believe that currencies are a separate asset class, their job is to actively manage the currency in an attempt to add some value to underlying fund performance by anticipating exchange rate moves.

Mackenzie's Cundill Value fund tends to hedge (i.e. eliminate) foreign currency exposure so that the fund's performance reflects only the pure return of their stock picks.

Finally, fully RSP eligible foreign index funds offer the opportunity to gain exposure to foreign markets without the currency exposure. TD Bank, Altamira, and Royal Bank all offer such funds. To read more about them, and how they work, see this older article.

Recommendation

Theories on currency exchange rates suggest that a U.S./Canadian dollar exchange rate would be US$0.70 to US$0.73 per Canadian dollar. The fact that it's gone beyond that may be nothing more than a temporary overshoot. Economic theory tends to hold over time, but there are significant interim periods that can cause us to question its validity. And we've just capped nearly five years of shorter-term deviation from the so-called equilibrium price.

I would not recommend taking any action on currency at this point. The rise in the dollar is substantially complete, in my opinion. Focus instead on investment issues when structuring your portfolios. It's time better spent.

Correction - publishing of proxy votes

A few weeks ago, I wrote about the controversy of Canadian fund managers publicizing how they vote the shares they hold on behalf of unitholders. I highlighted Meritas as one Canadian example that is progressive in this regard. I neglected to mention others.

Ethical Funds discloses their voting record online. In fact, they list their firm-wide record on one page for all visitors to see. And while they don't publicize their voting record, Acuity Investment Management does make the information available to requesting unitholders and financial advisors.

Some may notice that the few firms that disclose this information fall into the category of socially responsible investment (SRI) funds. However, not all SRI funds disclose their votes. These firms should be duly recognized for raising the bar.

Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at dha@danhallett.com
 
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