Wednesday, November 14, 2012

Currency Hedging Myth

Canadian ETF manufacturers reacted to the great Canadian dollar bull of 2004 through 2007 by attaching a currency hedge to most of their global and international offerings. One example is the iShares S&P 500 Index Fund (XSP) which seeks to replicate the performance of the S&P 500 Hedged to Canadian Dollars Index. According to iShares Canada “The S&P500 Hedged to Canadian Dollars Index is the S&P500 index with US dollar currency exposure removed, so that the returns of the S&P 500 stocks will not be impacted by changes in the US/Canadian dollar exchanges rates.

The ETF guys are responding to Canadian investor demand for currency hedging because of the great Canadian dollar bull of 2003 through to 2007. Basically a 4-year pop preceded and followed by years of flat price congestion which could drag of for several more years.

This is a clip from Nancy Woods (who used to be a GT letter subscriber), The Globe and Mail Published Friday, Aug. 19 2011, “If you invest in a gold ETF that is not hedged and the U.S. dollar strengthens (rises in value versus the Canadian dollar) you would lose some of your investment. If the US dollar weakens then your investment will gain simply from the currency change. Both these examples are irrespective of a change in the actual price of the ETF.”

This is a clip from Investoedia: “consider the performance of the S&P/TSX Composite during the second half of 2008. The index fell 38% during this period - one of the worst performances of equity markets worldwide - amid plunging commodity prices and a global sell off in all asset classes. The Canadian dollar fell almost 20% versus the U.S. dollar over this period. A U.S. investor who was invested in the Canadian market during this period would therefore have had total returns - excluding dividends for the sake of simplicity - of -58% over this six-month period.

Clearly since the Canadian dollar price peak of $1.10 in November 2007 there has been no benefit to owners of Canadian dollar hedged products over the past five years. Our chart is the monthly closes of US$ RIMM vs. the CDN$ RIM. Note in the period of 2003 through 2007 local U.S. investors in RIMM had better returns than did local Canadian investors in RIM due to the weaker US$. Note during the 2008 to date during a period of relatively flat CDN$ both CDN and US investors lost equally in terms of local currency. The lesson here is when we diversify by country was also need to diversify by currency

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