…that is the currency question!

All in all, 2015 was a disappointing year for investors, one that was characterized by heightened volatility in all asset classes. The only real winner was the US dollar which soared in value against all major world currencies, including of course our Canadian dollar. This graph illustrates the volatility in CAD-USD exchange from 1975 to the present. You can see just how precipitous the recent decline in the loonie has been.

As consumers, we all know about the problems associated with a weak Canadian dollar. Travel outside the country becomes more onerous. The cost of groceries, cars, books and other imported goods goes up. As investors, we also need to understand the impact of currency exchange on our investments.

When the loonie is falling in value in relation to other world currencies, this has the effect of increasing the value of our US and foreign investments, once these are translated back to Canadian dollars. The opposite occurs when the loonie is on the rise; the windfall profits turn to losses.

In 2015, our loonie fell in relation to most major currencies, not just the US dollar. As a result, the MSCI Europe Australasia Far East (EAFE) index, a benchmark for investing outside North America, returned 5.8 per cent last year, when measured in the currencies of the index’s component countries. In Canadian dollars, it soared 19.5 per cent.

While currency exchange is highly volatile and unpredictable, usually we will see trends develop, the impact of which can be felt for some years. For example, the US benchmark index, the S&P 500, delivered an annualized total return of 15.1 per cent in U.S. dollars, over the last three years ending Dec. 31, 2015. The same index, in Canadian dollars, returned 28.6 per cent over the same period, almost double.

Now imagine what happens when the opposite trend is in place, such as we saw in the 5- year period between 2002 and 2007, when the loonie climbed from a low of $0.61 USD back to parity with the greenback.

One way to deal with this problem is currency hedging, a strategy that ETF and mutual fund managers can appeal to, in order to effectively neutralize all currency-related fluctuations. As a result, investors reap the returns of the underlying investments of the fund, no more no less.

The Canadian dollar recently dipped as low as $0.68 USD, and is now hovering around $0.73, a pretty substantial bounce in a very short period of time. The Bank of Canada’s decision not to lower interest rates further gave the loonie a boost. The anticipation that oil prices will soon stabilize is also supporting our petro-currency. So at this stage, currency hedging may be a wise move in some cases. Problem is most mutual fund managers do not use these strategies actively. Some US and foreign equity funds are available in both un-hedged and currency neutral versions, leaving the decision to hedge or not to the investor and their advisors. Still others do not hedge and no currency neutral version of the fund is available, which poses a different dilemma. In sum, expect currency hedging to be a subject of conversation in up-coming investment reviews.