With the Canadian dollar at four-year lows, attention has turned to the economy and the impact of the loonie’s devaluation on investors. Many economists are forecasting that the Canadian dollar will fall below US$0.89 in 2014.
National Bank analysts believe that the large current account deficit, and hence the dependency on capital inflows, leaves the Canadian dollar vulnerable to further declines. However, they view this development as a net positive for the economy and for S&P/TSX earnings.
Martin Roberge, Canaccord Genuity’s North American portfolio strategist and quantitative analyst, observes that ever since the loonie rose above US$0.90 in 2009, Canada has suffered a chronic trade deficit.
Roberge concludes that the weaker dollar is likely to prevail because a number of key drivers remain bearish, such as stronger U.S. retail sales, lagging commodity prices and foreign outflows of Canadian bonds.
Such movements will affect investors with exposure to foreign currency.
Given the outperformance of the American markets over the last few years, many investors have large holdings in U.S. investments. For those with unhedged investments, a falling Canadian dollar is a good thing because it improves returns on the U.S. holdings.
Conversely, investors holding hedged positions aren’t necessarily in a difficult spot. They might miss the added gains, but they are protected should the Canadian dollar turn around.
There are many ways to invest in the falling loonie, with plenty of unhedged exchange-traded funds and mutual funds on the market. Investors can also look for individual companies that benefit from a weaker dollar.
An example would be a company whose costs are mostly in Canadian dollars but with the majority of its sales in U.S. dollars. Companies that will be relatively unaffected are those with both costs and sales primarily in U.S. dollars or matched to the local currency.
Most susceptible are companies with costs in U.S. dollars but revenue in Canadian currency.
Some data indicates that trying to benefit from currency movements might not be worth the effort.
RBC found that over periods of 15 years or longer, the impact of exchanges between the Canadian dollar and the U.S. dollar on investment returns gets closer and closer to zero.
Hedging can also lead to significant additional costs and can act as a drag on total return over the long term.
While less of a concern when hedging U.S. dollars, it becomes an issue when dealing with emerging markets and some of the more difficult markets to hedge.
It can be argued that hedging is unnecessary in a properly diversified global portfolio. Through diversification, a portfolio made up of multiple different currencies will be subject to less foreign exchange risk.
Ultimately the diversification acts as a natural hedge because a rise in one currency tends to cancel out another and vice versa.
Investors who wish to be cautious with their hedging could apply a hedging strategy to some of the portfolio and leave the balance unhedged.
This will furnish some protection in the event that the dollar rises, while also providing some upside should the loonie continue to weaken. •
