With the surprise display of strength by the Canadian dollar over the last 2 months, a summer road trip to the U.S. is making a little bit more sense—but just a little and probably not for long.
Since May, the Canadian dollar climbed from just under US$0.73 to just under US$0.80 on a weaker U.S. dollar and improved Canadian economic data leading to a more hawkish Bank of Canada. As a result, buying things in U.S. dollars just got about 9% cheaper!
What does this mean for Canadians? The good news is approximately half of Canada’s imports come from the U.S. and U.S. sourced goods are cheaper for Canadians. The bad news is that approximately 75% of our exports go to the U.S. and a stronger Canadian dollar challenges exports, growth and inflation. And from an investment standpoint, a strong Canadian dollar generally puts downward pressure on U.S. investment returns as they are translated back to Canadian dollars.
Currencies impact the total return of your investments
Consider this example: you own a U.S. denominated stock that returns 3.0% in U.S. dollars, at the same time the Canadian dollar appreciates 1.0% vs. the U.S. dollar. Therefore the total return of the U.S. denominated stock is 2.0% in Canadian dollars. This relationship between investment return, currency return and total return can be applied to all foreign investments.
It is clear that foreign currencies and exchange rates can be a source of opportunity and risk for an investment portfolio. The Canadian dollar and U.S. dollar are just two of 32 currencies we analyze as part of our currency strategy. At MD, we have a dedicated team to identify the opportunities and risks to potentially improve portfolio performance.
The MD currency strategy—making currency management dynamic
To find the best opportunities to generate value for our clients, MD employs the currency expertise of CIBC Asset Management. At no additional cost to MD clients, the team provides access to a currency strategy typically reserved for institutional level investors. Our strategy identifies fundamental reasons that explain currency behavior.
In Canada, equity funds generally have static currency policies. This could be for a number of reasons: currency specialists can add costs and/or dynamic currency funds may not “fit in” with the fund provider’s existing product suite. In addition, equity managers focused on stock picking (as they should) may not have the time, resources and skills to successfully implement a dynamic strategy.
The MD currency strategy is part of our holistic investment management process and adapts based on our current currency views. We offer unhedged foreign equity funds and overlay our dynamic currency strategy.
Professional currency management, simplicity and opportunity
Applying a single approach across a broad basket of currencies and all of our foreign equity funds allows us to provide MD clients with:
- Professional currency management—decisions require a structured process for research, analysis and execution as currencies are volatile and variables are highly complex with considerations for cyclicality, market sentiment, central bank activity and the economic environment.
- Simplified decision making—currency decisions are part of the investment management strategy, there is no need to separately execute currency positions or manually buy and sell funds with different currency policies.
- Diversification and potential excess returns—the approach adds additional potential sources of return and the strategy has added strong risk-adjusted value across foreign equity funds since its inception.
A higher Canadian dollar might not last
We currently don’t see a strong opportunity here. That’s because fundamental indicators aren’t overly supportive of a higher Canadian dollar, and a higher Canadian dollar makes it harder to achieve the Bank of Canada’s inflation objectives.
As a result, the currency strategy has not made a change due to the short-term Canadian dollar activity—instead we remain fully unhedged the U.S. dollar which recognizes the overall downward trend of the Canadian dollar vs. the U.S. dollar in recent years.
So if you’re thinking about that trip to the U.S. or some cross-border shopping, you’d better hit the road before it’s too late.
Mark Fairbairn, CFA, B.Eng., is a Senior Investment Analyst with the Investment Management team at MD Financial Management. He is responsible for the non-North American equity funds and pools as well as the currency overlay program within the equity funds.