A Post By Mike Onotsky
Have you heard of the term ‘currency hedging?’ How about ‘currency neutral?’ Many investment vehicles these days are offered in Currency Neutral versions, helping investors offset the effects of our dollar’s movements on their portfolios.
To currency hedge you’re betting on the ups and downs in the value of the Canadian dollar as compared to the value of other currencies, such as the U.S. dollar or the Euro. Whether or not to implement Currency Hedging with your investments can be a difficult decision.
Let’s take a look at why one should or shouldn’t venture down this path.
What is “Hedging?"
Hedging of any kind is a risk mitigation, or reduction, strategy. Believe it or not, when you buy life insurance, you are “hedging” against the risks associated with death. You buy insurance coverage so that, should you pass away, your beneficiaries are protected against the loss of income or other consequences that would occur as a result.
When it comes to investments, hedging is one way for the investor or fund manager to lower the downside risk of an investment by holding other products within a portfolio that might lessen the potential loss to the focal investment(s). It’s a way to achieve balance.
When someone buys an investment in a foreign currency, there is not only the risk of the investment itself going up or down, there is also the risk, here in Canada, of the Canadian dollar gaining or losing value against whatever currency the investment is in.
For example, you may buy the ABC US Equity Fund which is invested directly in US stocks and, regardless of what the US stock market does, if the Canadian dollar gains or loses against the US dollar, this too will have an effect on the fund’s performance.
In some cases, you may want to hedge against currency risk if you are a little more risk averse. In others, you may want to not hedge against currency if you have a strong feeling that the Canadian dollar is headed in a particular direction.
Sometimes a gain or loss against the US dollar (or any other single currency) is not necessarily a reflection of the Canadian dollar itself. For example, when the Canadian dollar weakens against the US, it could be as a result of the US dollar’s strength not the Canadian dollar’s weakness.
The US dollar could gain across many currencies and this possibility should be taken into consideration when looking at the bigger picture and not just how we are affected here in the Great White North.
To Hedge or Not To Hedge?
Should you buy investments or funds that are currency hedged or not? As with most investment related questions; it depends!
If the Canadian dollar was about to rise against the US dollar, you would be better to buy a US dollar version of the US fund so that the Canadian dollar uptick would buy more units in US dollars , taking the investment higher.
Conversely, if the Canadian dollar was likely to lose value, you would be better off in the CAD version of the US fund so that the fund would grow more as the Canadian dollar drops against the US dollar.
Of course, playing the currency game adds another element of risk to the portfolio. You’re betting on both the currency movement AND the investment movement.
The easiest option is to put your funds into a “currency neutral,” or currency hedged, version of the same fund. With this kind of fund its performance is based only on the investment return and not currency return.
Or course, there is a small cost to hedge. The fund manager will purchase alternative investments in the portfolio, which will allow him to hedge. These new investment vehicles are always an added expense.
Where Do We Go From Here?
Currently, as of May 10, 2016, the Canadian dollar is gaining ground on the US dollar and is close to $0.77 US. Most economists and advisors feel that this trend is not sustainable for long. If the price of oil continues to increase the Canadian dollar could climb higher. However, the general feeling is the Canadian dollar will drop back to the mid 70’s by the end of the year.
If this is the case, one would be better in funds that are held in CAD dollars so that they would benefit from the strength of the US dollar.
What’s the Catch?
No one really knows where things are headed for certain. All we can do is make a well informed decision about our savings and future goals.
This is where I come into the picture. I can help you plan out your next financial move. If you are unsure as to the hedge vs not hedge question, talk to me and we’ll put an investment plan in place that’s right for you.
Do you have a question? Please write a comment below or visit Mike Onotsky’s profile page. Or visit Erb and Erb Insurance Brokers Ltd. Financial Services Section.
Thanks for reading.