Currency War Part 1

Good day,

As the loonie has been the world’s best-performing currency year-to-date, this has beaten up the Canadian investor diversified into international securities. Millions of Canadians are likely looking at their portfolio statements wondering why YTD figures aren’t that exciting when the S&P 500 has had strong returns.

It’s worth noting that international diversification makes complete sense fundamentally and the YTD decline of approximately 1.5% on the resource-heavy TSX, speaks to this view.

So if you invested only in Canada this year, you probably haven’t seen much happen and if you invested internationally, you still wouldn’t have seen much happen as the gains you might have made on your international names would have been eroded in Canadian dollar terms.

Our largest portfolio program, The Willoughby Investment Pool, illustrates how even top stock picking isn’t immune to rapid currency swings. Investors in the program had a great start to the year with a 6.4% return to the end of April, but the Loonie climbed 8.49% against the USD since the beginning of May, which has taken away much of the year’s progress (see chart below showing the rapid decline in the USD).

During the 4-month period (May through August) when the USD witnessed the 8.49% decline I mentioned, the portfolio’s US stock holdings saw a strong 6.49% return (19.47% annualized). Like most Canadians, I don’t see this on my statement, as the healthy returns have been eroded when looking at the holdings in Canadian dollars. (Roughly 2% decline (+6.49% equity selection, -8.49% USD decline)).

Some readers might be wondering what type of consideration is given to currency hedging. This is an interesting and highly debated topic among portfolio managers. There are highly regarded global portfolio management firms that are dead set against hedging with the belief that over the long run, the cost of hedging currency erodes portfolio returns. We don’t often see such rapid currency swings especially for the first world developed countries so one can argue that a blanket, “no hedge” policy isn’t a bad thing for long term investors. That said, hedging might keep investors “feeling” better in the short-term so they can become better long-term investors.

Investors need to remember that meeting long-term financial objectives is no longer possible using GICs and government bonds. To see tax and inflation adjusted returns, we need to stomach a certain level of volatility whether it be security or currency related. While the loonie could climb a little further, history shows that most markets drop too much and climb too much before reverting to the mean.

The portfolio’s disciplined security selection approach will not change. We will continue to buy companies with (i) strong fundamentals, and (ii) showing upward pricing momentum. When we strip currency out of the equation, the investment approach has once again worked this year. When the loonie eventually reverses its trend, investors holding US securities will be rewarded.

PS. A strong loonie can hurt Canadian stocks too. More on that next week.

Have a good weekend!


Daniel Popescu CFP, CIM, FMA, FCSI

President & CEO


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