Hello and welcome to the Download. I’m your host, Dave Richardson. And today I have Sarah Riopelle, senior portfolio manager and vice president from RBC Global Asset Management. And I wanted to talk about currency today. The Canadian dollar has been weak throughout the Covid-19 crisis for a number of reasons. And of course, as a Canadian investor, if we look at a U.S. example, if we buy an investment in the U.S. and then we convert our Canadian dollars to U.S. dollars, we sell that investment, we bring our U.S. dollars back to convert to Canadian dollars. And if the Canadian dollar has gone down, it’s actually impacted, it’s had a positive impact on our returns. So if you look at the S&P 500, at one point last week, it has actually got pretty close to being even for the year in Canadian dollar terms. Bottom line, currency matters in your portfolio. And Sarah manages some of the biggest portfolios in Canada. Sarah, how do you think about managing currency when you’re managing portfolios?
Thanks, Dave. That’s a great question. Our largest currency exposure is to the U.S. dollar. So we focus on that one the most. It’s the currency pair that we would probably look to hedge in the portfolios, if and when the opportunity arises. As a reminder, there are two ways that we can manage currencies in the funds. The first is in the underlying funds. As a general rule, we hedge 100 % of our fixed income funds and our equity funds are all unhedged. But we do take the opportunity to actively hedge some of that exposure when we think there’s an opportunity to add value or to add Alpha. And then the second level is when we are set up to hedge currencies at the top fund level. We don’t currently have any hedges in place. But it’s important to keep in mind that we don’t have to hedge. We look at hedging as another tool in our toolkit. It’s a way to either add basis points of Alpha when there are opportunities in the markets to manage that, or it’s also to help us manage some of the risks in the portfolios. It’s going to be highly dependent on market fundamentals, the Alpha opportunity and the available risk budget that we have within the portfolios. « So that’s kind of the way that we think about. You mentioned the weakness in the Canadian dollar. There are a number of reasons why the Canadian dollar, we think, can continue to weaken further from here. And that’s why we’re not ready to put on any hedges in place just yet. Some of these concerns include weaker oil, as you know, slower global growth, — because the Canadian economy is very tied to global growth and trade — and current account deficits. And also we’re expecting some negative data to come out in the Canadian economy over the coming months. Most people focus on the level of the exchange rate. It’s currently about 1,41, U.S. dollar relative to CAD. We certainly pay attention to the level, but we’re also concerned about valuations. And so when we look at our valuation models, they show that the Canadian dollar is cheap. It’s about 16 % below fair value, but we don’t think it’s cheap enough yet. So our research shows that currencies can push beyond a 20 % undervalued threshold on these valuation models that we’ve constructed. They don’t tend to stay there very long. And that’s because exchange rates factor in a lot of economic behaviours of businesses and households. So, for example, if you have a company that operates in the U.S. and you can source some production inputs from Canada when they’re 20 % cheaper, you’re likely going to make that move. And that kind of decision is going to slow down that pace of decline in the currency, which is why it doesn’t stay at those undervalued levels for a very long time. But in times of financial and economic stress, like we’re going through right now, you could easily see those currencies move more than what historically is typical. So it’s possible that the Canadian dollar could get to 25 % or even 30 % undervalued. So we’re going to be watching these developments closely, make adjustments to the portfolios, if and when those opportunities arise. But we still think that there’s some room for more weakness in the Canadian dollar over the coming months.
And clear from your comments, particularly with respect to adding Alpha —Alpha is the return you get that beats the market effectively, for a simple explanation —currency is one of those ways that you can add Alpha as an investor in your portfolio. But then you start to talk about hedging and valuation, and purchasing power parity, and all the factors that come into thinking about currency. And of course, the currency market is a market that’s more volatile than equities even. And, for me anyways, with my portfolio, I’m glad to have someone like you making those decisions, forming around currency, because it’s something that’s very important. But it’s very difficult for an individual investor, to wrap their head around and actually implement in a cost effective manner into the management of their own portfolio.
Yeah, absolutely. I totally agree. And I have a large team of people on the currency desk that work with me to look for these opportunities and manage the currency exposures within the portfolios.
Always good to have a team. Wish I had one here, especially for all the gardening work I’m going to have to do this weekend. Sarah thank you for joining us today and putting some light on the importance of currency.
Thanks very much.