Download Global investing: Understanding currency risk and

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Global investing:
Understanding currency risk and opportunity
Diversification is a cornerstone of building an investment portfolio. Investors who want to be truly diversified
in order to reduce volatility and smooth out returns over time should consider the benefits of global investing.
Many investors focus their diversification efforts only on
investing in different asset classes, such as fixed income and
equities, or different sectors, such as financial companies
and commodities.
Another important key diversification strategy is to invest in
companies based in other countries, as the world’s markets
do not move in tandem. With Canada’s markets representing
less than 5% of the global economy, investing in foreign
markets can allow investors to access additional
opportunities. Yet, in addition to the opportunities global
investing brings, it can also bring along additional risks,
one of which is currency risk.
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When investing in mutual funds that hold securities
denominated in a currency other than Canadian dollars,
such as U.S. stocks, this foreign currency exposure becomes
an additional risk factor. Your portfolio will not only be
affected by changes in the price of the stock or bond, but by
exchange rates. If the Canadian dollar declines, this can add
to the returns of mutual funds that invest in foreign markets.
However, when the Canadian dollar climbs against other
foreign currencies, the value of investments denominated in
other currencies declines.
Many investors may be uncertain about how currency
movements can affect their returns and what can be
done to reduce risk and protect their portfolios against
increased volatility.
Falling Canadian dollar
Rising Canadian dollar
Value of your
foreign investment
Value of your
foreign investment
rises
falls
For example, if your foreign investment generated an 8%
rate of return in one year but the Canadian dollar lost 8% of
its value during the same period, your net return would be
zero, as you need to convert the sales proceeds back to
Canadian dollars.
Managing risk
Hedging is not always necessary; some currency exposure
can be beneficial as it enhances diversification within the
portfolio. If the portfolio manager expects certain foreign
currencies to perform well against the Canadian dollar, they
may choose to keep the stocks denominated in that
currency and benefit from any appreciation. Another
strategy used by portfolio managers with currency expertise is
directly investing in a certain currency that they believe is
going to increase in value, therefore benefiting the portfolio
as a whole (portfolio managers call this a ‘currency overlay’).
As more and more investors seek the diversification benefits
of investing a portion of their portfolio in global assets, they
need to be aware of the additional risks involved.
Exchange rate movements impact your foreign investments
$1.20
Nov. 2007: $1,000 USD = $921 CAD
$1.10
Exchange rate $CAN/$US
If investors are uncertain, they can invest in mutual funds
run by portfolio managers who use sophisticated currency
risk management strategies. One strategy is called hedging.
Hedging is when a portfolio manager locks in the exchange
rate and then converts everything back to Canadian dollars
at a predetermined, fixed rate. Consider this example: if a
U.S. stock is purchased, the stock would be converted at a
specific rate back to Canadian dollars so that any fluctuation
of the U.S. dollar against the Canadian dollar (while you
owned this stock) would not affect the value of your
portfolio. For investors, hedging can reduce the uncertainty
that comes with currency fluctuations.
$1.00
$0.90
$0.80
$0.70
$0.60
Mar. 2009: $1,000 USD = $1,299 CAD
’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15
Source: Bloomberg, as at June 30, 2015w
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please
read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may
not be repeated. The information contained in this sales tool is designed to provide you with general information related to
investment alternatives and strategies and is not intended to be comprehensive investment advice applicable to the circumstances
of the individual. We strongly recommend that you consult with a financial advisor prior to making any investment decisions.
The commentaries contained herein are provided as a general source of information based on information available as of June 2014
and should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities. Every effort has
been made to ensure accuracy in these commentaries at the time of publication, however accuracy cannot be guaranteed. Market
conditions may change and the manager accepts no responsibility for individual investment decisions arising from the use of or
reliance on the information contained herein. Publication Date: July 30, 2015.
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Talk to your financial advisor about how to manage the unique risks and
opportunities of global investing.