How will the U.S. dollar's depreciation affect my mutual funds?

Jamie Golombek, vice-president of taxation and estate planning at AIM Trimark Investments, has the answer.

Jamie Golombek 9 June, 2003 | 1:00PM
Dear Expert:

How has the Canadian dollar's increase in value against the U.S. dollar affected mutual funds that have U.S. equity holdings? Also, what is the effect of this on some of the U.S.-dollar-denominated versions of underlying funds that are denominated in Canadian dollars? My understanding is that these funds are priced in Canadian dollars, and all they do is a simple net-asset-value conversion from Canadian to U.S. dollars.

Expert Answer:

The significant depreciation of the U.S. dollar relative to the Canadian dollar in 2003 has prompted many questions such as yours. Many Canadian mutual funds are available to investors in a U.S. dollar version, which enables investors to maintain their investment in U.S. dollars. Due to fluctuations in the US$/C$ exchange rate, there will always be a difference between the returns of the U.S. dollar and Canadian dollar versions of funds that is equal to the change in the exchange rate. Should an investor sell his or her U.S. dollar fund and convert back to Canadian dollars, he or she would wind up with essentially the same total return as an investor in the Canadian dollar version of the same fund.

Mutual funds that invest in securities denominated in foreign currencies are subject to gains or losses in those currencies relative to the currency in which the fund itself is denominated. For example, a U.S. equity fund denominated in Canadian dollars invests in U.S. stocks and pays for them in U.S. dollars. If the value of the U.S. dollar falls relative to the Canadian dollar, the Canadian dollar values of the U.S. stocks in the portfolio also fall. As a result, investors would see a lower return than they might expect by comparing such a fund to U.S.-dollar-denominated indices.

Investors may hear that the S&P 500 is up 10.35% in 2003 for example, and wonder why there is such a large discrepancy between that number and what their U.S. equity fund has returned over the same time period. The same currency denomination must be used for a meaningful comparison. The same effect will also occur in Canadian equity funds that invest a portion of the portfolio in foreign stocks. Should those foreign currencies depreciate, the portfolio will be negatively affected, while foreign currency gains would benefit the fund.

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No statement in this article should be construed as a recommendation to buy or sell securities or to provide investment advice or individual financial planning. Morningstar Canada does not provide specific portfolio advice and recommends the use of a qualified financial planner when appropriate.

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Jamie Golombek

Jamie Golombek