Currency movements can present an element of uncertainty for Canadian investors holding mutual funds or ETFs that invest in foreign securities. The value of the currency used to buy or sell the investments may change, which is called currency risk.
Currency risk arises from the change in price of one currency versus another. When investors have assets invested outside of Canada, they face currency risk if their portfolios are not hedged. A declining Canadian dollar versus foreign currencies can add to the returns of mutual funds and ETFs that invest in foreign markets, while a rising Canadian dollar can negatively impact returns on foreign investments.
How can currency affect my investments?
When the Canadian dollar changes in value against foreign currencies, investors who hold unhedged foreign investments are affected. Keep in mind that global and international mutual funds and ETFs are often exposed to more than one currency, and not all currencies move in tandem.
If you were to buy a pair of shoes in the U.S. for the equivalent of C$100 and the Canadian dollar strengthens relative to the U.S. dollar over the following month, fewer Canadian dollars will be required to purchase that same pair of shoes.
C$
By contrast, if the Canadian dollar weakens relative to the U.S. dollar over the month, more Canadian dollars will be required to purchase that same pair of shoes.
C$
The same is true when investment managers buy foreign securities; they have to convert Canadian dollars into the local currency to purchase a foreign company’s stock or bonds. When the time comes to sell these investments, the sale is made in the foreign currency, which is then converted back to Canadian dollars. In the period between the purchase and the sale of the securities, the value of the Canadian dollar relative to the foreign currency may have changed. That transaction can add or detract from your return, depending on whether the Canadian dollar has strengthened or weakened over this period.
Full exposure to currency fluctuations (Unhedged) – A focus on the belief that over the long-term currency fluctuations will tend to even out.
Investment experience:
Return on foreign securities
+/- Change in foreign exchange rate
Protect investments from currency fluctuations (Hedged/Currency neutral) – A Canadian investor receives a return solely based on the change in value of the underlying assets, without the effect of changes in currency values.
Investment experience:
Return on foreign securities
= Total investment return
Tactically hedge – Where the portfolio manager manages the hedging in the fund based on current market conditions – this could include at times, no hedge, a partial hedge to a full hedge depending on the fund’s investment strategy and the portfolio manager’s flexibility to manage this, based on current conditions and situations.
Investment experience:
Return on foreign securities
+/- Impact of currency hedging strategy