Loonie Troubles: Currency Fluctuation: How Does it Affect Your Investment Portfolio?

11 April, 2016

The Canadian dollar has fallen back down to earth, tumbling from $0.93 CDN/US$ in July, 2014, to just over $0.71 in January of 2016.* So, how does this affect your investment portfolio? For this instance, let’s look at the relationship between the

The Canadian dollar has fallen back down to earth, tumbling from $0.93 CDN/US$ in July, 2014, to just over $0.71 in January of 2016.* 

So, how does this affect your investment portfolio? 

For this instance, let’s look at the relationship between the Canadian and US currencies, and your ownership of the corporations that are based in those two regions. 

The first currency pressure is the direct impact that changing currency values have on the corporations that you own through investing in a portfolio of securities. As the Canadian dollar has declined in relation to the US dollar, Canadian corporations have seen a loss in purchasing power when buying anything denominated in US currency. If a Canadian car manufacturer needs to purchase parts from a US company, those parts cost more than they did before, so that Canadian company will likely see a decrease in profit margins. 

However, if a Canadian parts dealer was selling parts to a US automotive manufacturer, they may now experience an increase in orders from that US company, because the US company can now purchase more in parts for their dollar than they could before. 

That is a narrow example of how currency pressures can directly affect the companies that you own. Now let’s look at how currency exchanges affect foreign investments in your portfolio. 

If you buy a US equity fund in your portfolio, you pay Canadian dollars to own investments held in the US. Those underlying companies you own are held in US dollars. So, when you buy and sell those investments, you do so through the current exchange rates. I’ll give you an example. 
For the calendar year of 2015, here are the returns for two of the main Canadian and US stock indexes**: 

Canada (S&P/TSX) - 8.32% 
US (S&P500) +1.38% 

Those returns are local, meaning they do not take into account any currency exchanges that might take place for the investor owning those securities. Now let’s compare those returns when translated back to Canadian dollars. 

Canada (S&P/TSX) - 8.32% 
US (S&P500) +21.58% 

That’s a big difference. A Canadian investor who owned companies in Canada did not see any direct currency exchange effects on those returns because no currency exchange took place. A Canadian investor owning US companies saw a dramatic difference because of the change in relative currency values during the time that investor owned those investments. 

Many of our clients saw positive performance for 2015 that was somewhere in the middle of those two sets of performance figures. The quick reason for that is the fact that we use very diversified portfolios for our clients. We spread out risk to reduce volatility. 

Now, if I was a Canadian investor with a diversified portfolio and I was looking at those return figures, I might think two things. First, I’m glad I was able to generate returns on my portfolio in a year where the North American markets didn’t grow very much at all. Second, should I be worried that the inverse could happen, and owning US investments in the future could see the opposite effect? If the Canadian dollar surges again, will I see significant losses in my US equity investments as a result? 

It’s first important to note that the fund companies you invest with also manage currency risk within the portfolio. Many of the managers we use for US equity investing have been saying the Canadian dollar will depreciate eventually, and that $0.93 CDN for each US $1 just didn’t reflect the actual purchasing power of both countries. Many of the managers had the ability to hedge the currency risk in their funds, which means reducing the impact any potential currency fluctuation would have on portfolio returns, but the majority felt that what we saw last year was a likely outcome. 

Secondly, what is the Canadian dollar really worth compared to the US dollar? How important is it to take currency fluctuation into account when building a portfolio? This question gets a lot more complicated, and for that, we will defer to the experts over at Mawer Investments. Click here  for an article that discusses in more depth how currency fluctuations affect your portfolio. 

The short answer? Your portfolio is the hedge. Trust in the basic premise of diversification. 

*Source: Globe and Mail 
**Source: Mawer Investments