Oct 06 2009

To Hedge or Not to Hedge…that is the question!

To Hedge or Not to Hedge…that is the question!

In a recent publication in the Globe and Mail, Scotia Capital’s portfolio strategist Vincent Delisle stated that Canada represents 3.7% of the MSCI World Index (source: Globe and Mail Tuesday, September 8, 2009 02:10 PM, “Buy Canada, says Scotia”).

While Canada is undoubtedly a great place to invest, to achieve broad portfolio diversification it is generally recommended to have exposure in both the US and internationally. However, when we invest outside of Canada we face what is known as “exchange rate risk”. Specifically this is the currency exchange rate between Canada and other countries. In my opinion, it’s an important consideration for your portfolio.

We’ll begin by looking at the US broad market. A representative mutual fund would be the TD US Index Fund (f-class). The investment objective of the fund is to provide long-term growth of capital by primarily purchasing U.S. equity securities to track the performance of The Standard & Poor’s 500 Total Return Index (S&P 500 Index). The S&P 500 Index is comprised of 500 widely-held U.S. companies. If we compare it to the currency hedged version of the same fund (the “currency-hedged version” has a similar objective except it also seeks to eliminate substantially the fund’s foreign currency exposure.) you’ll see the performance is quite different.

The Effect of Currency Hedging

The Effect of Currency Hedging

If we now look outside of North America, a representative mutual fund would be the TD International Index fund (f-class). The investment objective is to track the Morgan Stanley Capital International Europe, Australasia and Far East Index (MSCI EAFE Index). The MSCI EAFE Index is a broadly diversified index consisting of equity securities of companies domiciled in developed markets outside of the U.S. and Canada. The “currency-hedged version” has a similar objective except it also seeks to eliminate substantially the fund’s foreign currency exposure. In this graph you’ll see the impact of currency exposure is less than the Canada versus the United States.

 

 Source: Morningstar Paltrak as of August 31, 2009

Whether you choose to currency hedge your portfolio or not, is a matter of strategy. It’s best to inquire if a currency-hedged version of your investment exists and analyze whether the impact of currency is substantial or not.

Don Maycock, P. Eng, CFP, CIM is an independent certified financial planner financial advisor.  If you have a question or comment please contact me at don@donmaycock.com

Disclaimer:” “Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.”

 

 

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