How currency impacts your portfolio

As an investor, you don't need to be able to make currency calls yourself, but you do need to understand their impact on your portfolio.

Shehryar Khan, CFA 25 September, 2017 | 11:00PM

 

 

Shehryar Khan: When it comes to traveling, Canadians are acutely aware of the impact currencies can play on the total cost of their trip. It's not so different when it comes to our portfolios. For those investors with unhedged exposure to foreign equities and bonds, changes in the value of the Canadian dollar can at times have an outsized impact on returns. Since reaching it's high in late 2010, the Canadian dollar has been on a steady decline against most major currencies which has been a strong tailwind for non-domestic holdings. If an investor was unhedged, there was nothing to complain about as the devaluation of the dollar added to the strong market returns we have seen in the past few years. However, since bottoming out at below 70 cents US in early 2016, the Canadian dollar has had a strong rally back, and the results weren't as pretty for unhedged investors.

To examine the impact of the changing Canadian dollar, let's take a look at the hedged and unhedged versions of the iShares Core MSCI EAFE IMI ETF over the last 2 years. The three-month and two-year numbers are significantly different, illustrating the divergence in returns that can be caused simply by currency exposure.

This isn't to say that investors should jump ship and sell their unhedged funds in favour of hedged versions. Currency is another aspect of investing that needs to be taken into consideration.

For actively managed funds, just because a fund is unhedged doesn't mean that the manager ignores currency; they just tend to look for it on a company-specific level, instead of a blanket hedge on the total portfolio. It also pays to take a look at which currencies you have exposure to: The fact that U.S dollar tends to serve as the reserve currency of the world in times of a crisis means that you can make a case for having U.S. dollar exposure in your portfolio to help shelter your portfolio from the storm in a crisis. The same applies to other currencies that tend to appreciate in times of turmoil, such as the euro and Swiss franc. There is also the question of diversification: Hedging your portfolio completely tends to reduce the diversification benefits of investing abroad.

On the other hand, like interest rates, currency movements are notoriously hard to forecast. For investors who would rather remove them from the equation entirely, choosing an ETF or fund that hedges currency may be appropriate for a portion or all of your portfolio.

Like with choosing where to travel, there's no single right or wrong answer when it comes to what we should do with the currency exposure in our portfolio. As an investor, you don't need to be able to make currency calls yourself, but you do need to understand their impact on your portfolio.

For Morningstar, I'm Shehryar Khan.

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Shehryar Khan, CFA

Shehryar Khan, CFA  Shehryar Khan, CFA, is a senior investment analyst for Morningstar’s Investment Management group.