Understanding Currency Impact

Good day,

As many of you know the Bank of Canada increased interest rates this week for the first time in seven years on optimism about the Canadian economy. As investors saw this coming for some time now, the Canadian dollar has been rising over the last few months.

It is important for investors to understand currency fluctuations as they can influence portfolio returns. As the US economy has been the leader for some 8 years now, its stock market has been one of the strongest performers during the period. As such, having a significant allocation to US securities has not only proven profitable for investors, but has helped offset some of the downside from volatile Canadian and global securities. Although US stocks are not as cheap as they once were, the US economy is still the largest and currently the strongest in the world and it wouldn’t be prudent to eliminate US holdings simply due to short-term foreign exchange fluctuations.

To understand the rationale behind portfolio construction, let’s take a simple example where an equity investor held a 50% allocation to US stocks and a 50% allocation to its US counterpart during 2017. As I type this the Toronto Stock Exchange shows a negative return of 0.7% year to date, while the US’ S&P500 has gained 9.85% so as stated above, owning securities in the US has been the right move. That said, this year to date, the US dollar has declined 5.79% against the loonie so for Canadian investors, the decline of the US dollar has eroded much of the US gains on paper.

Keep in mind that few investors have an allocation of 100% to equities given their lack of appetite for risk, so there are other factors at play which would influence the numbers I list above. In my view, a significant allocation to Canadian equities isn’t generally ideal given the lack of sector diversification that exists on the TSX. That said, maintaining a bias towards Canadian equities acts as a foreign exchange hedge for investors who also hold global investments.

Our firm’s clients hold international securities in individual accounts and our investment pools. Our current US and overseas allocation has impacted paper results year to date, but our philosophy has not changed. We buy global businesses— those which have strong balance sheets, grow their earnings and provide the goods and services the world needs.

Have a good weekend!

Danny

PS I’ve included an FX chart from Bill Richardson, an advisor in one of our Ontario offices.

 

 

 

 

 

 

 

 

 

 

 

 

 

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Daniel Popescu CFP, CIM, FMA, FCSI
President & CEO

MNP Tower, 3100-1021 West Hastings St.
Vancouver, BC V6E 0C3
T: 604-558-6830/1(877) 588-6822
F: 604-558-6823
harbourfrontwealth.com

 

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