Currency risk for investors

Canada represents only about three per cent of the world’s capital markets. Investors are often reminded therefore, that they should consider placing some of their investments outside Canada. This is generally sound advice. Acting on it however, should not be done without due consideration of currency-risk, which can greatly magnify normal financial market-risk.

When investing in Canadian financial products, currency-risk is not an issue. We invest Canadian dollars and receive proceeds in Canadian funds. Once we diversify our investments to include for instance, U.S. products, currency-risk looms large.

As an example, let’s assume we make a U.S. investment which gains a respectable 10 per cent over a one-year period. During that same year however, the U.S. dollar depreciates by 13 per cent relative to the Canadian dollar. Our overall position is a loss of some three per cent. Of course, had the stock value also declined, our loss would have been even more magnified by the additional loss on foreign exchange. So does this suggest we should avoid investing in  U.S. markets? Not at all.

There are a number of fully-hedged U.S. investments which can essentially eliminate this currency-risk. The Claymore U.S. Fundamental Index Exchange Traded Fund (CLU) for example, provides the investor with exposure to some 1,000 of the largest U.S. listed companies, on a fully-hedged basis. Investment in a fully-hedged U.S. ETF has the same market risk as in an all-Canadian ETF investment. However the investor is protected from the risk of a negative currency move.

Hedged products can similarly be found for investments in other countries such as Brazil, Russia, India and China. When multiple countries are included in an investment, the currency risk becomes less of an issue because currency changes with one country are often balanced by opposite moves with others. It therefore follows that if one invests in an Emerging Markets mutual or exchange-traded fund, which may involve a broader base of 20 or more countries, currency risk is minimal, and hedging is not necessary.

Hedged financial products will charge a slightly higher Management Expense Ratio (MER) than would otherwise be the case. Often though, that charge is minimal. In the  above CLU example, the total MER which includes the hedging feature, is a very reasonable 0.69. 

Do consider including some non-Canadian components in your investment portfolio. Do be mindful however of the increased currency-risk you run. Consider products that not only provide foreign exposure, but also do so at reasonable cost on either a partially or totally-hedged basis — particularly if that investment is in a single country such as the U.S.

A retired corporate executive, enjoying post-retirement as a financial consultant, Peter Dolezal is the author of three books. His most recent, The Smart Canadian Wealth-Builder, Is now available at Tanner’s Books, and in other bookstores.