Protecting Your Portfolio in the Rising Canadian Dollar Environment

I’m sure you have heard how the S&P 500 Index has finally reached its before-tech-bubble-popped levels. And it only took seven years to do so. But while the U.S. investors are undoubtedly celebrating, their northern counterparts could still be years away from putting on their happy hats.

Why? According to one rather conservative school of thought, the party pooper is the Canadian dollar, which, in the past four years, has staged an impressive comeback from about US$0.65 to more than US$0.92. Basically, unless Canadian investors have bought a currency hedge of some sort, investing in nominally profitable U.S.-listed or U.S.-indexed securities have actually cost them money.

Yet, on face value, everyone will tell you that diversifying across asset classes and countries is the only way to reach that ever-elusive investment success. However, conservative economists believe that, at present, it might be a good idea to avoid U.S. investments, particularly as the Canadian dollar is gunning for parity with the shaky greenback and the Canadian economy is outperforming its southern counterpart.

But what should Canadian investors do who are either already invested in U.S. securities or planning to do so? At this point, it might be a good idea to offset currency risk with investments that are designed as currency hedges. Major banks, for example, offer something called “currency neutral mutual funds,” which are mandated to maintain neutral betas of all of their holdings on any given day.

As is the case with any analysis, there is an opposing and more speculative approach that perceives the rising Canadian dollar as the cup being half full rather than half empty. I’m talking about the popular argument that because the Canadian dollar is strong, Canadian investors should buy cheap U.S. securities.

There is an economic foundation for this argument. Canada may be the second-largest country in the world, but its global market cap weighing is only three percent. This is why it makes economic sense for Canadian investors to diversify in the U.S. as well as globally.

Where do I stand in this little conundrum? I value and evaluate everyone’s opinion equally. Two, three, five… a hundred heads are always better than one. But when faced with black-and-white propositions, I’m always looking for those inevitable shades of gray.

In this case, I don’t think Canadian investors should pull out of U.S. securities completely, if for no other reason than there is limited potential for excitement back home. However, I also believe U.S. securities are not as cheap for Canadian investors as the strong Canadian dollar would like us to think. This is why I would go for a currency hedge, in addition to increased exposure to other foreign markets.

Just bear in mind that global exposure does not necessarily mean buying specific securities listed on foreign exchanges. You can always opt for mutual funds with global mandate issued right here at home. Or you can buy successful Canadian companies interlisted in the U.S., but with global operations… and particularly those that report their revenues in strong Canadian dollars and their costs in weaker foreign currencies.